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Asymmetric information in frictional markets for liquidity: collateralized credit vs asset sale

Florian Madison ()

No 220, ECON - Working Papers from Department of Economics - University of Zurich

Abstract: The aim of this paper is to identify an optimal contract design for institutions exchanging liquidity on a decentralized asset market with Lucas-trees subject to asymmetric information. Within a search-theoretic dynamic general equilibrium model, I establish a non-equivalence between collateralized credit and an outright sale of assets, and show through a signaling game with Perfect Bayesian Nash Equilibria, why depositing assets as collateral is a dominant strategy. In addition, I provide a compelling reason why financial institutions apply haircuts to securities offered as collateral, which justifies the observed overcollateralization on the over-the-counter market for liquidity since the eruption of the global financial crisis.

Keywords: Liquidity; asymmetric information; collateral; undefeated equilibrium (search for similar items in EconPapers)
JEL-codes: D82 E44 G12 G21 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban and nep-mac
Date: 2016-03, Revised 2017-09
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