CoCos under short-term uncertainty

TL;DR

This paper extends a credit risk model for CoCo bonds by incorporating short-term uncertainty with two sources of noise and report times, analyzing how noisy market information and reporting affect default and conversion.

Contribution

It introduces a novel model combining market noise and reporting times to better understand CoCo bond defaults under short-term uncertainty.

Findings

Model captures impact of noisy information on credit events

Analysis of how report times influence default and conversion

Provides a framework for pricing CoCo bonds with short-term uncertainty

Abstract

In this paper we analyze an extension of the Jeanblanc and Valchev (2005) model by considering a short-term uncertainty model with two noises. It is a combination of the ideas of Duffie and Lando (2001) and Jeanblanc and Valchev (2005): share quotations of the firm are available at the financial market, and these can be seen as noisy information about the fundamental value, or the firm's asset, from which a low level produces the credit event. We assume there are also reports of the firm, release times, where this short-term uncertainty disappears. This credit event model is used to describe conversion and default in a CoCo bond.