  This paper investigates whether a financial system can be made more stable if
financial institutions share risk by exchanging contingent convertible (CoCo)
debt obligations. The question is framed in a financial network model of debt
and equity interlinkages with the addition of a variant of the CoCo that
converts continuously when a bank's equity-debt ratio drops to a trigger level.
The main theoretical result is a complete characterization of the clearing
problem for the interbank debt and equity at the maturity of the obligations.
We then introduce stylized networks to study when introducing contingent
convertible bonds improves financial stability, as well as specific networks
for which contingent convertible bonds do not provide uniformly improved system
performance. To return to the main question, we examine the EU financial
network at the time of the 2011 EBA stress test to do comparative statics to
study the implications of CoCo debt on financial stability. It is found that by
replacing all unsecured interbank debt by standardized CoCo interbank debt
securities, systemic risk in the EU will decrease and bank shareholder value
will increase.
