Information Aggregation, Security Design and Currency Swaps

Bhagwan Chowdhry, Mark Grinblatt and David Levine

No 8746, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: A model of security design based on the principle of information aggregation and alignment is used to show that (i) firms needing to finance their operations should issue different securities to different groups of investors in order to aggregate their disparate information and (ii) each security should be highly correlated (closely aligned) with the private information signal of the investor to whom it is marketed. This alignment reduces the adverse selection penalty paid by a firm with superior information. Adverse selection costs are often contingent on ex post publicly observable and contractible state variables such as exchange rates. In such cases, debt contracts are dominated by currency swaps. Moreover, optimal securities are derivative contracts that are contingent on state variables that influence adverse selection costs. This is because the netting of cash flows in these derivative contracts, in effect, alters the state-by-state seniority of different claims in a desirable way.

JEL-codes: G0 G1 (search for similar items in EconPapers)
Date: 2002-01
New Economics Papers: this item is included in nep-ifn
Note: AP
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Citations: View citations in EconPapers (4)

Published as Chowdhry, Bhagwan, Mark Grinblatt and David Levine. "Information Aggregation, Security Design, And Currency Swaps," Journal of Political Economy, 2002, v110(3,Jun), 609-633.

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