Security Design with Interim Public Information
45 Pages Posted: 8 Mar 2013 Last revised: 11 Oct 2016
Date Written: October 10, 2016
We consider a security design problem where public information about the security’s underlying cash-flow arrives between trading periods. The optimal security minimizes less-than-full realization of gains from trade due to limited cash in the market, which may depend on the interim information. We show that the optimal security can be expressed as a convex combination of securities solving minimization problems for which the solutions share many debt-like features but exhibit endogenous tranching. We provide conditions for the non-optimality of standard debt contracts and show that implementation of the class of optimal securities can be achieved by mezzanine tranche retention, providing a public information rationale for departure from the pecking order.
Keywords: Security Design, Symmetric Information Arrival, Tranching
JEL Classification: D84, D86, E51, G14
Suggested Citation: Suggested Citation