To Pool or Not to Pool? Security Design in OTC Markets
40 Pages Posted: 21 Nov 2016 Last revised: 18 Dec 2019
Date Written: December 17, 2019
We study security issuers' decision whether to pool assets when facing counterparties endowed with market power, as is common in over-the-counter markets. Unlike in competitive markets, pooling assets may be suboptimal in the presence of market power --- both privately and socially --- in particular, when the potential gains from trade are large. In these cases, pooling assets reduces the elasticity of trade volume in the relevant part of the payoff distribution, exacerbating inefficient rationing associated with the exercise of market power. Our results shed light on recently observed time-variation in the prevalence of pooling in financial markets.
Keywords: Pooling, Security Design, Liquidity, Adverse Selection, Imperfect Competition, OTC Markets
JEL Classification: D82, G32, L14
Suggested Citation: Suggested Citation