Separating equilibria, under-pricing and security design

Dan Bernhardt, Kostas Koufopoulos and Giulio Trigilia
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Kostas Koufopoulos: University of York
Giulio Trigilia: University of Rochester

The Warwick Economics Research Paper Series (TWERPS) from University of Warwick, Department of Economics

Abstract: Classical security design papers equate competitive capital markets to securities being fairly priced in expectation. We revisit Nachman and Noe (1994)'s adverse selection setting, modeling capital-market competition as free entry of investors, and allowing firms to propose prices of securities, as happens in private securities placements and bank lending. We show that separating equilibria exist in which high types issue under-priced debt, while low types issue more informationally-sensitive securities (e.g., equity). We also uncover pooling equilibria in which firms issue under-priced debt. These results provide foundations for the pecking-order theory of external finance, and positive profits for uninformed lenders.

Keywords: Adverse selection; strictly positive profits; security design (search for similar items in EconPapers)
Date: 2021
New Economics Papers: this item is included in nep-cwa
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Journal Article: Separating equilibria, underpricing and security design (2022)
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Persistent link: https://EconPapers.repec.org/RePEc:wrk:warwec:1329

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