The Handbook of Hybrid Securities: Convertible Bonds, CoCo Bonds and Bail-In

13 Multi-Factor Models for Hybrids

13.1 INTRODUCTION

In Section 6.5 the sensitivity of both a convertible and a CoCo bond has been investigated with respect to share price, interest rate, and volatility movements. From this theoretical analysis we retain that there are multiple factors contributing to the theoretical price of a hybrid security. For each asset class we can single out specific situations where one factor stands out and is responsible for the price movements in the contingent convertible. A CoCo bond that is about to be triggered will be most sensitive to equity movements. In this extreme situation a CoCo demonstrates its equity behavior. On the other side of the spectrum, when the trigger is very distant, the CoCo can be considered equivalent to a senior corporate bond.

These theoretical findings were supported by the earlier outcome of a statistical experiment carried out in Section 2.3.1. For a sample security, we revealed how much of the day-to-day movements in the market price of the security can be explained by changes in interest rates, credit spreads, or equity prices. The same answer prevails: there is no single factor capable of explaining all of the day-to-day movements in the price of a convertible bond or a similar hybrid security such as a CoCo bond. Yet, in most of the valuation models we have been studying so far, the share price was the only stochastic component taken into consideration. Equity was the only source of risk and its stochastic process ...