Portfolio Liquidity and Security Design with Private Information

Strategic liquidity supply and security design

Peter DeMarzo, David Frankel and Yu Jin

The Review of Financial Studies, 2021, vol. 34, issue 12, 5841-5885

Abstract: A privately informed seller seeks to liquidate a portfolio to raise cash. Each asset’s liquidity thus depends on the impact of its sale on the value of the entire portfolio. We demonstrate the importance of cross-signaling and derive sufficient conditions for a liquidity “pecking order” that determines the order of sale. For assets backed by a common pool, liquidity naturally aligns with seniority. Finally, we extend the portfolio liquidation game to consider security design and demonstrate the optimality of pooling securities and selling senior tranches or debt secured by the pool, with retention increasing in asset quality or informational asymmetry.

JEL-codes: G12 G14 G21 G32 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (5)

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