The Impact of CoCo Bonds on Systemic Risk Considering Liquidity Risk

This paper investigates the impact of Contingent Convertible (CoCo bonds) on systemic risk. Based on the network and liquidity channel, we compare the differences in default contagion and clearing payment between financial systems with and without CoCo bonds. By analyzing the sensitivity of equilibrium payment and the market price of illiquid assets, we find that CoCo bonds affect the performance of intervention policies mainly by changing the relative liability matrix of the banking system. Finally, we illustrate our model using the data from 2017 annual reports of 15 Chinese commercial banks. We find that CoCo bonds could enhance the risk resilience of issuing banks to a certain degree, but the default of issuing banks will lead to systemically wide contagion when the external shock is too large