Using Economic Experiments to Improve Contingent Convertible Capital Bonds

This Commentary describes experiments conducted to study alternative designs for a new type of financial security, CoCo bonds, that is being used in some European countries to manage the risk of financial crises. CoCo bonds are bank-issued debt that converts to equity when a trigger is breached. The conversion into equity serves to recapitalize a bank during financial distress, precisely when it is hardest to raise capital. The types of trigger used for all CoCos issued thus far are defined in terms of book capital. The experiments we conducted explore the effects of using triggers that are based on market prices.