Dynamic coordination with flexible security design

Subject

Economics

Publishing details

Social Sciences Research Network

Authors / Editors

Ozdenoren E; Yuan K; Zhang S

Biographies

Publication Year

2018

Abstract

Borrowers obtain funding for production by issuing securities backed by the current-period div- idend and resale price of a long-lived collateral asset. Borrowers are privately informed about the collateral quality. A higher (lower) resale price lowers (increases) adverse selection and makes the as- set a good (lousy) collateral. Conversely, good (lousy) collateral has a high (low) resale price. When only equity is issued, this dynamic feedback between the asset price and collateral quality can lead to multiple equilibria. Optimal flexible security design eliminates multiple equilibria fragility and improves welfare through intertemporal coordination. When the security design is rigid, multiple equilibria reemerge

Keywords

Liquidity; Security design; Financial fragility; Repo

Series

Social Sciences Research Network