Addressing systemic risk using contingent convertible debt – A network analysis

Abstract

We construct a balance sheet network model to study the interconnectedness of a banking system. A simulation analysis of the buffer effect of contingent convertible (CoCo) debt in controlling contagion in a theoretical banking network model is followed by calibrating the model using 13F filings. We find that CoCo debt conversion significantly mitigates systemic risk, with a dual-trigger CoCo debt design being more effective in protecting the surviving banks. A two-tranche CoCo debt design combines the benefits of single and dual-trigger CoCo debt. The trade-offs in different designs of CoCo triggers can be evaluated in a network simulation model, as developed in this work.