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Design of contingent capital with a stock price trigger for mandatory conversion
Contingent capital (CC), a regulatory debt that must convert into common equity when a bank?s equity value falls below a specified threshold (a trigger), does not in general lead to a unique equilibrium in the prices of the bank?s equity and CC. Multiplicity or absence of equilibrium arises because economic agents are not allowed to choose a conversion policy in their best interests. The lack of unique equilibrium introduces the potential for price manipulation, market uncertainty, inefficient capital allocation, and unreliability of conversion. Because CC may not convert to equity in a ...