Dynamic Asset-Backed Security Design

Emre Ozdenoren, Kathy Yuan and Shengxing Zhang

The Review of Economic Studies, 2023, vol. 90, issue 6, 3282-3314

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.

Keywords: Liquidity; Dynamic price feedback; Intertemporal coordination; Security design; Multiple equilibria; Self-fulfilling prices; Financial fragility; Haircut; Repo; Repo runs; Asset-backed security; Collateral; Limited commitment; Adverse selection; Non-bank financial intermediary; Market-based financial intermediation (search for similar items in EconPapers)
Date: 2023
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Working Paper: Dynamic asset-backed security design (2023)
Working Paper: Dynamic asset-backed security design (2022)
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