World Scientific
  • Search
  •   
Skip main navigation

Cookies Notification

We use cookies on this site to enhance your user experience. By continuing to browse the site, you consent to the use of our cookies. Learn More
×

System Upgrade on Tue, May 28th, 2024 at 2am (EDT)

Existing users will be able to log into the site and access content. However, E-commerce and registration of new users may not be available for up to 12 hours.
For online purchase, please visit us again. Contact us at [email protected] for any enquiries.

PRICING SOVEREIGN CONTINGENT CONVERTIBLE DEBT

    https://doi.org/10.1142/S0219024918500498Cited by:0 (Source: Crossref)

    We develop a pricing model for Sovereign Contingent Convertible bonds (S-CoCo) with payment standstills triggered by a sovereign’s Credit Default Swap (CDS) spread. We model CDS spread regime switching, which is prevalent during crises, as a hidden Markov process, coupled with a mean-reverting stochastic process of spread levels under fixed regimes, in order to obtain S-CoCo prices through simulation. The paper uses the pricing model in a Longstaff–Schwartz American option pricing framework to compute future state contingent S-CoCo prices for risk management. Dual trigger pricing is also discussed using the idiosyncratic CDS spread for the sovereign debt together with a broad market index. Numerical results are reported using S-CoCo designs for Greece, Italy and Germany with both the pricing and contingent pricing models.

    References

    • C. Alexander & A. Kaeck (2008) Regime dependent determinants of credit default swap spreads, Journal of Banking and Finance 32 (6), 1008–1021. Crossref, Web of ScienceGoogle Scholar
    • J. Amato & E. Remolona (2003) The credit spread puzzle, BIS Quarterly Review 51–63. Google Scholar
    • M. G. Arghyrou & A. Kontonikas (2016) The EMU sovereign-debt crisis: Fundamentals, expectations and contagion, Journal of International Financial Markets, Institutions and Money 22 (4), 658–677. Crossref, Web of ScienceGoogle Scholar
    • P. Augustin (2014) Sovereign credit default swap premia, Journal of Investment Management 12 (2), 65–102. Google Scholar
    • S. Badaoui, L. Cathcart & L. El-Jahel (2013) Do sovereign credit default swaps represent a clean measure of sovereign default risk? A factor model approach, Journal of Banking & Finance 37 (7), 2392–2407. Crossref, Web of ScienceGoogle Scholar
    • J. Bai & P. Perron (1998) Evaluating and testing linear models with multiple structural changes, Econometrica 66 (1), 47–78. Crossref, Web of ScienceGoogle Scholar
    • Bank of England (2015) Workshop summary. In Bank of England Workshop on GDP Linked Bonds. Bank of England, http://www.bankofengland.co.uk/research/Pages/conferences/301115.aspx. Google Scholar
    • B. Barkbu, B. Eichengreen & A. Mody (2012) Financial crises and the multilateral response: What the historical record shows, Journal of International Economics 88 (2), 422–435. Crossref, Web of ScienceGoogle Scholar
    • E. Borensztein & P. Mauro (2004) The case for GDP-indexed bonds, Economic Policy 19 (38), 165–216. CrossrefGoogle Scholar
    • D. Brigo & A. Alfonsi (2005) Credit default swaps calibration and option pricing with the SSRD stochastic intensity and interest-rate model, Finance and Stochastics 9 (1), 29–42. Crossref, Web of ScienceGoogle Scholar
    • M. Brooke, R. Mendes, A. Pienkowski & E. Santor (2013) Sovereign default and state-contingent debt. Financial Stability Paper No. 27, Bank of England. Google Scholar
    • C. Calomiris & R. J. Herring (2013) How to design a contingent convertible debt requirement that helps solve our too-big-to-fail problem, Journal of Applied Corporate Finance 25, 21–44. CrossrefGoogle Scholar
    • R. Castellano & L. Scaccia (2014) Can CDS indexes signal future turmoils in the stock market? A Markov switching perspective, Central European Journal of Operations Research 22 (2), 285–305. Crossref, Web of ScienceGoogle Scholar
    • Y. Censor & S. A. Zenios (1997) Parallel Optimization: Theory, Algorithms, and Applications. New York: Oxford University Press. Google Scholar
    • A. Consiglio & S. A. Zenios (2015) The case for contingent convertible debt for sovereigns. Working Paper 15-13, The Wharton Financial Institutions Center, University of Pennsylvania, Philadelphia. Available at http://papers.ssrn.com/sol3/papers.cfm? abstract_id=2478380. Google Scholar
    • A. Consiglio & S. A. Zenios (2016) Risk management optimization for sovereign debt restructuring, Journal of Globalization and Development 6 (2), 181–214. CrossrefGoogle Scholar
    • A. Consiglio & S. A. Zenios (2018) Pricing and hedging GDP-linked bonds in incomplete markets, Journal of Economic Dynamics and Control 88, 137–155. Crossref, Web of ScienceGoogle Scholar
    • A. Consiglio, S. Lotfi & S. A. Zenios (2017) Portfolio diversification in the sovereign CDS market, Annals of Operations Research 266 (1–2), 5–33. Crossref, Web of ScienceGoogle Scholar
    • R. Cont & Y.-H. Kan (2011) Statistical modeling of credit default swap portfolios. Available at SSRN: http://ssrn.com/abstract=1771862. Google Scholar
    • A. Drud (2005) CONOPT. In GAMS: The Solvers Manual. GAMS Development Corporation. Google Scholar
    • F. Fabozzi, R. Giacometti & N. Tsuchida (2016) Factor decomposition of the eurozone sovereign CDS spreads, Journal of International Money and Finance 65, 1–23. Crossref, Web of ScienceGoogle Scholar
    • A. Fontana & M. Scheider (2010) An analysis of euro area sovereign CDS and their relation with government bonds. Working Paper 1271, European Central Bank. Google Scholar
    • P. Glasserman (2003) Monte Carlo Methods in Financial Engineering. New York: Springer-Verlag. CrossrefGoogle Scholar
    • F. F. Heinz & Y. Sun (2014) Sovereign CDS spreads in Europe — The role of global risk aversion, economic fundamentals, liquidity and spillovers. Working paper WP/14/17, International Monetary Fund, Washington, DC. Google Scholar
    • IMF (2017a) State-contingent debt instruments for sovereigns. Staff report, International Monetary Fund. Google Scholar
    • IMF (2017b) State-contingent debt instruments for sovereigns–annexes. Staff report, International Monetary Fund. Google Scholar
    • M. Kamstra & R. J. Shiller (2009) The case for trills: Giving the people and their pension funds a stake in the wealth of the nation, Discussion Paper 1717, Cowles Foundation for Research in Economics, Yale University, New Haven, CT. Google Scholar
    • J. N. Kapur (1989) Maximum-Entropy Models in Science and Engineering. India: Wiley. Google Scholar
    • S. Kotz, N. Balakrishnan & N. L. Johnson (2005) Dirichlet and inverted Dirichlet distributions. In: Continuous Multivariate Distributions, chapter 49, pp. 485–527. John Wiley & Sons, New York. CrossrefGoogle Scholar
    • Y. Li (2016) The long march towards an international legal framework for sovereign debt restructuring, Journal of Globalization and Development 6 (2), 329–341. CrossrefGoogle Scholar
    • F. A. Longstaff & E. S. Schwartz (2001) Valuing American options by simulation: A simple least-squares approach, The Review of Financial Studies 14 (1), 113–147. Crossref, Web of ScienceGoogle Scholar
    • F. A. Longstaff, J. Pan, L. H. Pedersen & K. J. Singleton (2011) How sovereign is sovereign credit risk? American Economic Journal: Macroeconomics 3, 75–103. Crossref, Web of ScienceGoogle Scholar
    • R. L. McDonald (2013) Contingent capital with a dual price trigger, Journal of Financial Stability 9 (2), 230–241. Crossref, Web of ScienceGoogle Scholar
    • J. M. Mulvey & S. A. Zenios (1994) Capturing the correlations of fixed-income instruments, Management Science 40, 1329–1342. Crossref, Web of ScienceGoogle Scholar
    • B. O’Donoghue, M. Peacock, J. Lee & L. Capriotti (2014) A spread-return mean-reverting model for credit spread dynamics, International Journal of Theoretical and Applied Finance 17 (3), 1450017. LinkGoogle Scholar
    • M. H. Schneider & S. A. Zenios (1990) A comparative study of algorithms for matrix balancing, Operations Research 38 (3), 439–455. Crossref, Web of ScienceGoogle Scholar
    • C. E. Shannon (1948) A mathematical theory of communication, The Bell System Technical Journal 27 (3), 379–423. Crossref, Web of ScienceGoogle Scholar
    Remember to check out the Most Cited Articles!

    Be inspired by these new titles
    With a wide range of areas, you're bound to find something you like.