Working Paper: CEPR ID: DP14306
Authors: Victoria Vanasco; Vladimir Asriyan
Abstract: We revisit the classic problem of a seller (e.g. firm) who is privately informed about her asset and needs to raise funds from uninformed buyers (e.g. investors) by issuing securities backed by her asset cash flows. In our setting, buyers post menus of contracts to screen the seller, but the seller cannot commit to accept contracts from only one buyer, i.e., markets are non-exclusive. We show that an equilibrium of this screening game always exists, it is unique and features semi-pooling allocations for a wide range of parameters. In equilibrium, the seller tranches her asset cash flows into a debt security (senior tranche) and a levered-equity security (junior tranche). Whereas the seller of a high quality asset only issues her senior tranche, the seller of a low quality asset issues both tranches but to distinct buyers. Consistent with this, whereas the senior tranche is priced at pooling valuation, the junior tranche is priced at low valuation. Our theory's positive predictions are consistent with recent empirical evidence on issuance and pricing of mortgage-backed securities, and we analyze its normative implications within the context of recent reforms aimed at enhancing transparency of financial markets.
Keywords: Adverse Selection; Security Design; Nonexclusivity; Tranching; Liquidity; Securitization; Transparency; Opacity; Complexity; Market Design
JEL Codes: D82; D83; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| nonexclusive markets (L17) | unique equilibrium (C62) |
| nonexclusive markets (L17) | dynamics of contract acceptance and pricing (D86) |
| nonexclusive markets prevent separation of seller types (L13) | semipooling equilibria (C62) |
| inability to commit to exclusive contracts (L14) | mispricing of senior tranche of securities (G12) |
| low-quality sellers mimic high-quality sellers (L15) | mispricing of senior tranche of securities (G12) |
| costly cash flow retention for low-type sellers (L14) | inability to effectively screen seller types (D82) |
| nonexclusive nature of the market (L17) | distortion in pricing of securities (G10) |