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CoCos with Extension Risk. A Structural Approach

Abstract

In this paper we obtain some formulas for pricing contingent convertibles subject to what we call extension risk, i.e., the possibility that the bond issuer does not buy back the bond at pre-specified call dates. We follow a structural approach and we address the finite and infinite maturity cases.

Keywords

  • Contingent capital
  • Coco bond
  • Extension risk
  • Callable bond

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Notes

  1. 1.

    By a lower Snell envelope of a discrete time \(\mathbb {F}\)-adapted process \(X:=\left( X_{i}\right) _{i=1}^{N}\), we understand the minus Snell envelope of \(-X.\) See, for instance, Sect. 2.2 in [14] for the definition of the Snell envelope of a process and its relationship with the problem of optimal stopping.

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Acknowledgments

The work of J.M. Corcuera is supported by the Grant of the Spanish MCINN MTM2013-40782. This research was partially carried out at CAS—Centre for Advanced Study at the Norwegian Academy of Science and Letters, Research group SEFE. J. Fajardo thanks financial support from CNPQ, grant 471131/2013-0.

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Correspondence to José Manuel Corcuera .

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Corcuera, J.M., Fajardo, J., Schoutens, W., Valdivia, A. (2016). CoCos with Extension Risk. A Structural Approach. In: Podolskij, M., Stelzer, R., Thorbjørnsen, S., Veraart, A. (eds) The Fascination of Probability, Statistics and their Applications. Springer, Cham. https://doi.org/10.1007/978-3-319-25826-3_21

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