Presentation – Paul de Moor and Okke Labout

Speaker:

Paul de Moor (Tilburg University)

Title:

Systemic Risk in Financial Networks: The Role of CoCo Bonds

Abstract:

This thesis investigates the effect of contingent capital bonds (CoCos) on systemic risk in interbank networks when banks cross-hold each other’s CoCo bonds. We consider both CoCos with stock price triggers in the model of Balter et al. (2023) and CoCos with accounting-based triggers in the model of Gupta et al. (2021). In the model of Balter et al. (2023), we analyze both the risk of contagion in a stylized banking network and the effect of a system-level shock in a banking network calibrated to data from the European Banking Authority (EBA). In our analysis of contagion effects, we find that the size of losses following a shock to a single bank bank is influenced by the CoCo contract parameters and the structure of the banking network. Our results for the model calibrated to the EBA data set indicate that CoCo debt can prevent bankruptcies following a system-level shock, in sync with reducing value for CoCo bond holders. A larger shock requires more CoCo debt to save banks from default. Furthermore, we find that non-bank creditors can benefit from replacing their claims with CoCo debt, given a sufficiently small recovery rate. In the model of Gupta et al. (2021), we analyze how interbank cross-holding of CoCo debt compares to a situation where CoCo debt is only held by external parties. We find that interbank cross-holding of CoCo debt can increase systemic risk when CoCo bonds are non-dilutive.

 

 

Speaker:

Okke Labout (Tilburg University)

Title:

Revisiting the recovery theorem: Why does practice refute theory?

Abstract:

The recovery theorem by Ross (2015) introduced a way to estimate the real-world transition probabilities using state prices. However, for the recovery theorem to work, four assumptions need to hold, and empirical papers show that some of these four assumptions do not hold in reality. In this thesis, I will refine the recovery theorem by adding one additional assumption: “(strong) rational expectations”. Furthermore, I find that if all five assumptions hold, the estimated pricing kernel becomes long-term risk neutral and that in a world where the risk-free (interest) rate is constant, the market is only influenced by idiosyncratic risk.