Valuation and Analysis of Zero-Coupon Contingent Capital Bonds

Abstract

We consider the valuation and analysis of zero-coupon contingent capital bonds (CCBs) in the structural framework. Using Doob's Optional Sampling Theorem (and making virtually no assumptions on asset value dynamics, the terms of conversion or the conversion trigger) we express the value of the CCB in terms of the effective loss imposed on CCB investors at conversion and quantify the impact that contingent capital has on traditional debt and equity. We show how a variety of conversion terms can be incorporated into a single framework and describe how they can be calibrated to ensure that seniority is respected and/or equity investors are not rewarded for poor performance. We provide numerical evidence indicating that the terms of conversion can fundamentally alter the nature of the CCB, a phenomenon that is of clear interest to investors, issuers and regulators.