(c) The dotted black line is a suggested trigger level for contingent capital calibrated by minimising a loss function which takes into account both Type I and Type II errors. Type I error is the probability that conversion occurs despite capital not being required. Type II error is the event that conversion does not occur despite capital being required. The loss function places greater weight on Type II errors. Note that the loss function takes into account the full range of banks, not just the average score for each set. (d) 30-day moving average of market capitalisation. 24  BIS central bankers’ speeches  Table 1: Estimated subsidy for UK and global banks $  Contingent claims / Kou(a)  Ratings(b)  2007  2008  2009  2010  2007– 2010 average  2007  2008  2009  2010  2007– 2010 average  UK  134  354  622  250  340  9  51  178  58  74  Global  496  1,308  2,294  924  1,256  33  211  528  197  242  a) Calculated using an extension to the Merton (1977) model developed by Kou (2002). It models changes in banks’ assets as being normally distributed with upward and downward “jumps” designed to reflect the possibility of extreme movements in asset values, and “fatten the tails” of the resulting distribution. This model is fitted to the prices of options written on the four largest UK banks’ equities.
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