Contingent Convertible Bonds for Sovereign Debt Risk Management

Andrea Consiglio, Stavros A. Zenios

Research output: Contribution to journalArticlepeer-review

1 Citation (Scopus)

Abstract

We consider convertible bonds that contractually stipulate payment standstill, contingent on a market indicator of a sovereign's credit worthiness breaching a distress threshold. This financial innovation limits ex ante the likelihood of debt crises and imposes ex post risk sharing between creditors and the debtor. Drawing from literature on contingent contracts, neglected risks, and bank CoCo, we extend prevailing arguments in favor of sovereign CoCo (S-CoCo). We discuss issues relating to their design: which market trigger, market discipline and sovereign incentives, and errors of false alarms or missed crises, and provide supporting evidence with eurozone data and a simple simulation on the use of S-CoCo. We develop a risk management model using these instruments to trade off the expected cost for sovereign financing over a long horizon, with tail risk. The model shows how contingent bonds can improve a country's debt risk profile. Using Greece as a case study the model illustrates improvements in expected cost vs. tail risk for the country when using contingent debt.
Original languageEnglish
Pages (from-to)1-24
Number of pages24
JournalJOURNAL OF GLOBALIZATION AND DEVELOPMENT
Volume9
Publication statusPublished - 2018

All Science Journal Classification (ASJC) codes

  • Geography, Planning and Development
  • Development
  • General Economics,Econometrics and Finance

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