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Contingent Capital With a Dual Price Trigger, Journal of Financial Stability

Abstract

This paper proposes a form of contingent capital for financial institutions that converts from debt to equity if two conditions are met: the firm's stock price is at or below a trigger value and the value of a financial institutions index is also at or below a trigger value. This structure protects financial firms during a crisis, when all are performing badly, but during normal times permits a bank performing badly to go bankrupt. I discuss a number of issues associated with the design of a contingent capital claim, including susceptibility to manipulation and whether conversion should be for a fixed dollar amount of shares or a fixed number of shares; the susceptibility of different contingent capital schemes to different kinds of errors (under and over-capitalization); and the losses likely to be incurred by shareholders upon the imposition of a requirement for contingent capital. I also present some illustrative pricing examples.

Type

Article

Author(s)

Robert L. McDonald

Date Published

2013

Citations

McDonald, L. Robert. 2013. Contingent Capital With a Dual Price Trigger. Journal of Financial Stability. 9(2): 230-241.

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