Pricing Models for CoCos

Abstract

Each CoCo bond is different and this lack of standardisation proves to be a real challenge. Also comparing CoCo bonds of different banks against each other is not straightforward. The actual valuation of a CoCo incorporates the modeling of both the trigger probability and the expected loss for the investor. Some would argue that modelling contingent debt is an impossible task. After all, how could one possibly model an accounting trigger taking place or a regulator pulling the non-viability trigger on a CoCo bond? The only CoCos for which an adequate financial model could deliver an acceptable theoretical price would be those with a market trigger. In such a case, the loss absorption mechanism is activated as soon as an observable variable such as for example a share price level or a credit default swap spreads drops below a specified barrier. However none of such CoCo bonds have been issued so far (De Spiegeleer et al. 2014).