Extracting implied volatilities from bank bonds

Abstract

In this work, we explore the information content of senior, subordinated and additional tier 1 (or contingent convertible) bonds issued by euro-area banks. We analyze both the asset volatility implied in senior and subordinated bonds and credit default swap market spreads, and the common equity tier 1 (CET1) ratio volatility extracted from additional tier 1 bonds secondary market spreads in the period from December 31, 2012 to March 31, 2021. Furthermore, we jointly consider the following important bank variables: asset, equity and CET1 ratio volatilities. In doing so, we can obtain the market view on credit spreads, banks balance sheet and capital ratio dynamics on a daily basis even if bank data are released quarterly. The approach can be used to monitor the risk of each bank, as perceived by the market, and to investigate banking fragility at a stand-alone or at a country level. Finally, we compare our estimated equity implied volatilities with the volatilities implied in equity option quotes and we show that this indicator depends on the model and the financial instruments considered in the calibration.

Keywords:

• Subordinated bonds
• AT1 bonds
• CoCo bonds
• Credit default swaps
• Capital requirements
• CET1 ratio
• Implied CET1 volatility
• Firm value models

JEL:

• C02
• G12
• G21

Acknowledgments

The authors are grateful to Pierluigi Bologna, Emilia Bonaccorsi di Patti, Antonio Di Cesare, Arianna Miglietta, and two anonymous referees for their helpful suggestions. The views expressed are those of the authors and do not necessarily reflect those of the Bank of Italy.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 See section 6.1 for a detailed discussion on the selection of $l_{{\alpha }_{ndl}}$ and $u_{{\alpha }_{ndl}}$.

2 For more details, see appendix A.1.1.

3 A review of barrier options pricing formulas in the context of Black and Scholes assumptions is provided in the appendix of Hilscher and Raviv (2014).

4 The ISIN code of the securities and some related information are publicly available on the Banca d'Italia website.

5 The banks in the sample are ABN AMRO Bank (H:ABN), Banco Bilbao Vizcaya Argentaria (E:BBVA), Banco BPM (I:BP), Banco Sabadell (E:BSAB), Banco Santander (E:SAN), Bankia (E:BKIA), Bankinter (E:BKT), BNP Paribas (F:BNP), Caixabank (E:CABK), Commerzbank (D:CBK), Crédit Agricole (F:CRDA), Deutsche Bank (D:DBK), Erste Group Bank (O:ERS), ING Groep (H:INGA), Intesa Sanpaolo (I:ISP), KBC Group (B:KB), Nordea Bank (M:NBH), Raiffeisen Bank International (O:RAI), Société générale (F:SGE), Unicredit (I:UCG), Unione di Banche Italiane (I:UBI). In April 2021 I:UBI was incorporated into I:ISP.

6 Note that we are analyzing the major European banks.

7 According to BBVA (2020) estimates the historical CET1 ratio volatility was below 3% in the period from 2008 to 2020 for a sample of main European banks.