How Are Coco Bonds Perceived? Going Concern, Gone Concern, or None of the Above?

Abstract

We investigate the effectiveness of CoCo bonds as a credible recapitalization or resolution tool for distressed banks in Europe. Using yields on CoCo and senior bank bonds, we construct a CoCo premium to capture bank stress and we analyze whether or not this premium is related to bank systemic risk, captured by the marginal expected shortfall (MES), as well as individual bank risk. We find that increases of the CoCo spread are positively associated with both bank systemic risk and bank default risk. These results suggest that market participants do not consider CoCo bonds as ‘going concern’ capital. Since we also find that senior and subordinated bondholders perceive the probability of a bail-in as higher during times of an elevated CoCo premium, this implies that CoCo bonds are not considered as a credible recovery or resolution tool under the BRRD regime. Furthermore, the impact of CoCo bonds is not limited to bank-specific systemic and credit risk but also affects the risk profile of other banks. Our results suggest that policy actions are needed to render the European bank bail-in regime more credible.