CoCo Bond and Systemic Risk

Issuing CoCo bonds is a possible way for banks to protect against economic uncertainty scenario. However, it remains unclear if CoCo bonds will be useful in loss absorption for issuers in the event of another financial distress. Using the model of Systemic Risk proposed by Brownlees and Engle (2016a), we estimated the expected capital shortfall for 103 banks that issue the CoCo bonds. The results show that CoCo can avoid the collapse of 6 institutions in the short term. Also, we design an event study that determines how the announce and the issue of CoCo bonds influence the systemic risk. The results show that the first issue can be interpreted for the market as a positive signal since the SRISK decrease. On the other hand, the SRISK increase when banks issue the second, thus this may reflect the investor’s fear of seeing the bank taking more capital.