Pricing Contingent Capital

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TITLE:  Pricing Contingent Capital

SPEAKER:  Paul Glasserman


Among the solutions proposed to the problem of banks "too big to fail" is contingent capital in the form of debt that converts to equity when a bank's regulatory capital ratio falls below a threshold. We analyze the dynamics of such a security with continuous conversion and derive closed form expressions for its value when the firm's assets are modeled as geometric Brownian motion and the conversion trigger is an asset-based capital ratio. A key step in the analysis is an explicit formula for the fraction of equity held by the original holders of the contingent capital debt as a function of the maximum drop in asset value. We contrast this analysis with the case of a market-based (rather than accounting-based) conversion trigger. This is joint work with Bezhad Nouri.

Paul Glasserman is the Jack R. Anderson Professor of Business at Columbia Business School, where he served as senior vice dean in 2004-2008. Since 2008, he has also been an academic visitor at the Federal Reserve Bank of New York. His research focuses on derivative securities, risk management, stochastic models, and simulation. His publications include the book Monte Carlo Methods in Financial Engineering, which received the 2005 I-Sim Outstanding Simulation Publication Award and the 2006 Lanchester Prize. He also received Risk magazine's 2007 Quant of the Year Award.


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