The Determinants of European Coco Spreads

Abstract: Contingent Convertible (Coco) bonds are hybrid capital securities that absorb losses when the capital of the issuing bank falls below a certain level. Previous research has mainly been focusing on the pricing of such instruments and this paper contributes to the eld by empirically examining the determinants of Coco bond spreads for European banks. By examining di erent samples, this study will search for di erences between Cocos with different characteristics such as rating and regulatory capital designation. The sample covers a set of 71 currently traded Cocos issued by listed European banks, accounting for over 30,000 panel observations. Firm speci c credit risk variables, initially identi ed by Merton (1974), are found to explain the largest part of the variations in Coco spreads. Individual bond liquidity and market wide variables are shown to complement the Merton variables in explaining Coco spread movements.