Contingent Convertible Bonds and Macroeconomic Stability in a Stock-Flow Consistent Agent-Based Model

In this paper, we assess the effects of contingent convertible bonds (CoCos) in terms of stability of the banking sector and the economy as a whole. The analysis builds upon a stock-flow consistent agent-based model. The paper argues that the bail-ins that result from the activation of CoCos in a crisis not only partially replace costly bailouts for the taxpayer, but also effectively prevent bank failures and contribute to higher average capital adequacy ratios. This stabilization of the banking sector is positive for the economy as a whole as long as the volume of CoCos in circulation is not too high. Above a certain volume, their activation negatively affects macroeconomic aggregates, as CoCos reinforce the effects of a crisis rather than mitigate them. It is therefore in the regulator's interest to control the expansion of the CoCo market