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Dynamic Asset Backed Security Design

Journal

Review of Economic Studies

Subject

Economics

Publishing details

Review of Economic Studies 2023 Vol 90:6 p 3282-3314

Authors / Editors

Ozdenoren E;Yuan K;Zhang S

Biographies

Emre Ozdenoren

Publication Year

2023

Abstract

Borrowers obtain liquidity by issuing securities backed by the current period payoff and resale price of a long-lived collateral asset, and they are privately informed about the payoff distribution. Asset price can be self-fulfilling: a higher asset price lowers adverse selection and allows borrowers to raise greater funding, which makes the asset more valuable, leading to multiple equilibria. Optimal security design eliminates multiple equilibria, improves welfare, and can be implemented as a repo contract. Persistent adverse selection lowers debt funding, generates volatility in asset prices and exacerbates credit crunches. The theory demonstrates the role of asset-backed securities on stability of market-based financial systems.

Available on ECCH

No


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