The contingent convertible bond (or CoCo) is designed as a bail-in tool, which is written down or converted to equity if the issuing bank is seriously troubled and thus its trigger is activated. The trigger could be either rule-based or discretion-based. I show theoretically that bail-in is less implementable and the associated bail-in risk is lower if the trigger is discretion-based since governments face greater political pressures from letting creditors take losses. The political pressure is greater since governments have the sole authority of activating the trigger and hence get blood on their hands. Furthermore, the pressures could be augmented by investors’ self-fulfilling expectations on government bailouts. I support this theoretic prediction with an empirical evidence, which shows that bail-in risk premiums on CoCos with discretion-based triggers are on average 1.13 to 2.91%p lower than CoCos with rule-based triggers.

The contingent convertible bond (or CoCo) is designed as a bail-in tool, which is written down or converted to equity if the issuing bank is seriously troubled and thus its trigger is activated. The trigger could be either rule-based or discretion-based. I show theoretically that bail-in is less implementable and the associated bail-in risk is lower if the trigger is discretion-based since governments face greater political pressures from letting creditors take losses. The political pressure is greater since governments have the sole authority of activating the trigger and hence get blood on their hands. Furthermore, the pressures could be augmented by investors’ self-fulfilling expectations on government bailouts. I support this theoretic prediction with an empirical evidence, which shows that bail-in risk premiums on CoCos with discretion-based triggers are on average 1.13 to 2.91%p lower than CoCos with rule-based triggers.

1. Introduction

2. A Theoretic Analysis
　2.1. Information structure
　2.2. CoCo market
　2.3. Government's behavior and equilibria

3. An Empirical Analysis
　3.1. Preliminaries
　3.2. Empirical analysis 1: the coupon rate
　3.3. Empirical analysis 2: the coupon residual

4. Conclusion

Appendix 1
Appendix 2
Figures and Tables
References