Contingent convertible bonds (or "CoCo bonds" or "CoCos") are hybrid capital instruments issued by banks, that, at least in theory, have the purpose of strengthening their capital in times of economic and capital crisis. Introduced since the major financial crisis of 2009, they have recently become a significant financing instrument for several major banking institutions, especially in Europe and in emerging countries.
The purchasers of these instruments are institutional investors of various kinds: banks, insurance companies, social security institutions and foundations, whereas small private investors are excluded from placement.
In this paper we analyze the European AT1 CoCo bonds from a twin perspective. Initially, from the perspective of an institutional investor interested in buying CoCos, we attempt, through econometric techniques, to identify the main variables that influence the level of prices and returns of this type of financial instrument, even in times of Coronavirus crisis. Subsequently, from the perspective of an institutional investor that wants to sell the AT1 CoCo bonds.
In normal conditions of the market and of the individual issuer, these instruments yield more than the debt instruments, including subordinated instruments, issued by the banks that placed them. This extra-return, which we can call "CoCo Premium", appears more tied to the characteristics of these instruments and to the general risk appetite of investors than to specific financial and economic variables.
From a valuation perspective, AT1 CoCo bonds are complex instruments: the somewhat "opaque" nature of the operating mechanisms, linked to non-market events of an accounting-regulatory nature, and characterized by particular ancillary clauses, makes these financial instruments more exposed than others to model risk during the valuation phase and to liquidity risk during the disinvestment phase.