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Pricing sovereign contingent convertible debt. (English) Zbl 1419.91608

Summary: 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.

MSC:

91G20 Derivative securities (option pricing, hedging, etc.)
91G40 Credit risk

Software:

GAMS; CONOPT
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Full Text: DOI arXiv

References:

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