Unobservable costly effort in security design

Matthew J. Robertson

Economics Letters, 2024, vol. 235, issue C

Abstract: I introduce unobservable costly effort into the canonical signalling model of security design. The choice of effort determines the quality of the security and creates an additional optimisation problem the firm must solve. My main result is that both optimal effort and optimal profits are decreasing in the firm’s preference for liquidity. I also show that optimal effort is greater under symmetric information. My approach provides a theoretical explanation for empirical results that cannot be obtained within the standard signalling framework. In addition, I extend existing methods to solve signalling models with endogenous private information.

Keywords: Signalling; Security design; Securitisation; Adverse selection; Costly effort (search for similar items in EconPapers)
JEL-codes: C72 D82 G23 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecolet:v:235:y:2024:i:c:s0165176524000569

DOI: 10.1016/j.econlet.2024.111573

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