The bail-in credibility: barking dogs seldom bite

Abstract

This paper studies the senior unsecured bondholders’ bail-in expectations and market monitoring following bail-in legislative events aimed at introducing new tools for subordination. We measure bail-in expectations using a difference in differences approach that compares the reaction to bail-in events of senior unsecured bonds to the reaction of non-bailinable bonds. Similarly, we measure senior unsecured bondholders’ monitoring activity by using a triple differencing analysis that compares the yield-risk sensitivity reaction of senior unsecured bonds with respect to that of non-bailinable bonds. Our results indicate unaffected bail-in expectations by senior unsecured bondholders who, accordingly, do not enhance their pricing of banks’ risk.

Appendix 1

The triple differencing empirical model is:

$${yld}_{ijt}=\alpha +{\alpha }_{i}+{\beta }_{3}\times {risk}_{jt}\times {uns}_{i}\times {post}_{t}+{\gamma }_{1}\times {risk}_{jt}\times {uns}_{i}+ {\gamma }_{2}\times {risk}_{jt}\times {post}_{t}+{\gamma }_{3}\times {uns}_{i}\times {post}_{t}+ {\delta }_{5}\times {risk}_{jt}+{\delta }_{6}\times {uns}_{i}+{\delta }_{7}\times {ttm}_{ijt}+{day}_{t}+{\mu }_{ijt}$$

We can assume that bank risk can take only two values (risk = s = safe or rsk = r = risky), that post can take two values (post = pre = before treatment or post = post = after treatment), that uns can take two values (uns = u = senior unsecured or uns = n = non-bailinable) and that E(u|uns, post, risk, X) = 0 (where X is the set of control variables in the DDD regression model). It can be shown (by calculating the expectations relative to the triple differencing empirical model) that the ${\beta }_{3}$ is the difference between two time-series changes in sensitivities:

$${\beta }_{1}=\left[\left({yield}_{|r u post}-{yield}_{|s u post}\right)+\left({yield}_{|r u pre}-{yield}_{|s u pre}\right)\right]-\left[\left({yield}_{|r n post}-{yield}_{|s n post}\right)+\left({yield}_{|r n pre}-{yield}_{|s n pre}\right)\right]$$

where (yld|r u post − yld|s u post) is a difference in expected values describing the sensitivity of the yield of a senior unsecured bond to an increase in risk from s to r, after the bail-in event. (yld|r u pre − yld|s u pre) is a difference in expected values describing the sensitivity of the yield of a senior unsecured bond to an increase in risk from s to r, before the bail-in event. (yld|r n post − yld|s n post) is a difference in expected values describing the sensitivity of the yield of a non-bailinable bond to an increase in risk from s to r, after the bail-in event. (yld|r n pre − yld|s n pre) is a difference in expected values describing the sensitivity of the yield of a non-bailinable bond to an increase in risk from s to r, before the bail-in event.