Structural Pricing of CoCos and Deposit Insurance with Regime Switching and Jumps

In this article, we develop a semi-analytical solution for a structural model that combines jump and regime switching risk. We use an Esscher transform that is applicable to regime switching double exponential jump diffusion to move from the historical world to the risk-neutral world. Further, we de...

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Bibliographic Details
Published in:Asia-Pacific financial markets 2020-12, Vol.27 (4), p.477-520
Main Authors: Le Courtois, Olivier, Su, Xiaoshan
Format: Article
Language:English
Subjects:
Balance sheets
Convertible bonds
Deposit insurance
Econometrics
Economic Theory/Quantitative Economics/Mathematical Methods
Economics and Finance
Exact solutions
Finance
Insurance
International Economics
Macroeconomics/Monetary Economics//Financial Economics
Original Research
Risk
Structural models
Switching
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Summary:In this article, we develop a semi-analytical solution for a structural model that combines jump and regime switching risk. We use an Esscher transform that is applicable to regime switching double exponential jump diffusion to move from the historical world to the risk-neutral world. Further, we define and implement a matrix Wiener–Hopf factorization associated with the latter process, allowing us to price the various components of balance sheet. We illustrate the model with a study of a bank that issues contingent convertible bonds (CoCos). Thus, we obtain valuation formulas for the bank’s equity, debt, deposits, CoCos, and deposit insurance. We also show in an illustration the respective effects of the jump risk and of regime switching on the values of all of a bank’s balance sheet components.
ISSN:1387-2834
1573-6946
DOI:10.1007/s10690-020-09304-6