Working Paper: CEPR ID: DP12596
Authors: Juan Ortner; Martin Schmalz
Abstract: We study optimal security design when the issuer and market participants agree to disagree about the characteristics of the asset to be securitized. We show that pooling assets can be optimal because it mitigates the effects of disagreement between issuer and investors, whereas tranching a cash-flow stream allows the issuer to exploit disagreement between investors. Interestingly, pooling and tranching can be complements. The optimality of debt with or without call provisions can be derived as a special case. In a model with multiple financing rounds, convertible securities naturally emerge to finance highly skewed ventures.
Keywords: disagreement; security design; optimism; overconfidence; pooling; tranching; behavioral finance
JEL Codes: G30; G32; D84; D86
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Issuer's optimism about cashflow distribution (G33) | Design of securities (G10) |
| Pooling assets (G11) | Better outcomes for the issuer (G24) |
| Design of tranching (G33) | Investor behavior and issuer outcomes (G24) |
| Pooling and tranching can enhance each other's effectiveness (C24) | Optimal security design (F52) |
| Issuer's discounting of future cashflows (E43) | Different security designs (F52) |