Abstract
This paper shows how the credit risk of CoCos materially differs from the credit risk of other defaultable securities, allowing us to replicate them with a portfolio of risk-free bonds and equity derivatives. We use a stochastic volatility model with jumps (SVJ) calibrated on credit and volatility data to compute the value of a traded CoCo. Using this model, we show how to extract new information-content about a bank from CoCo prices, computing an implied stock price trigger. From this perspective, we price a real-world CoCo and observe a potential mispricing. We analyse CoCos’ payoff profile, explaining why they carry significant endogenous risk. Finally, we discuss why they might not be suitable for many traditional fixed-income investors.
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