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  Issue 23 | Archive May 2015

Columbia Business School¡¯s Professor Paul Glasserman Shares His Research on Contingent Capital

On 13 April 2015, Professor Paul Glasserman, Jack R. Anderson Professor of Business at the Columbia Business School, gave a talk on contingent capital at NUS-RMI. Nearly 50 attendees were present to learn about the role of contingent convertible (cocos) bonds and bail-in debt as a way of averting disorderly bankruptcy. The audience at the seminar were a mix of professionals from various banking and financial institutions, NUS researchers, and students and alumni from RMI¡¯s Master of Science in Financial Engineering (MFE) program.

Titled ¡°Contingent Capital, Tail-Risk, and Debt-Induced Collapse,¡± the talk shed light on the research conducted by Prof. Glasserman together with Prof. Nan Chen, Behzad Nouri, and Markus Pelger. In their research they have investigated coco bonds and their incentive effects on the issuing firm. Adding to previous research on the topic they also developed a new structural model with endogenous default, debt rollover, and tail risk in the form of downward jumps in asset value.

Since the financial crisis, research has been focused on crisis management tools in the banking industry, like cocos. Stating that Contingent Capital is a proposed solution to the recent financial crisis, Prof. Glasserman, who is also the Research Director of the Program on Financial Studies at Columbia University, noted, ¡°If banks have mechanisms like cocos in place, then government bailouts become less likely.¡± Following a short introduction, he went into detail about the nature of cocos as debt that converts to equity when a bank is approaching financial distress.

Later, he dived into the details of debt-induced collapse and tail risk, discussing the consequences of both these phenomena. He stressed that the banks need to ¡°set the conversion trigger high enough relative to total debt,¡± in order to avoid disaster. Taking this as a premise, their upcoming research investigates the ¡°effect of contingent capital and debt maturity on capital structure, debt overhang, and asset substitution.¡±

¡°Along with the rest of the research findings, it was interesting to know that one of the incentives for a banking institution to issue cocos is if they are tax deductible, which makes them more popular in Europe than in US,¡± commented one MFE student who attended the talk. Another attendee shared his feedback saying, ¡°Research insights like these are very enlightening and challenge risk management professionals to think about crisis prevention.¡±

Jointly hosted by Centre for Quantitative Finance and RMI this research seminar was organized by the NUS Finance and Risk Management Cluster. These seminars aim to update staff, students and risk professionals with the latest cutting-edge knowledge on selected research topics of interest in risk management.

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Editor: Shivani Nakhare (rminsr@nus.edu.sg)