Information Aggregation, Security Design and Currency Swaps

30 Pages Posted: 11 Feb 2004

See all articles by Bhagwan Chowdhry

Bhagwan Chowdhry

University of California, Los Angeles (UCLA) - Finance Area

Mark Grinblatt

University of California, Los Angeles (UCLA) - Finance Area; Yale University - International Center for Finance; National Bureau of Economic Research (NBER)

David K. Levine

Washington University in St. Louis - Department of Economics; European University Institute - Robert Schuman Centre for Advanced Studies (RSCAS)

Multiple version iconThere are 3 versions of this paper

Date Written: January 2002

Abstract

A model of security design based on the principle of information aggregation and alignment is used to show that (i) firms needing to finance their operations should issue different securities to different groups of investors in order to aggregate their disparate information and (ii) each security should be highly correlated (closely aligned) with the private information signal of the investor to whom it is marketed. This alignment reduces the adverse selection penalty paid by a firm with superior information. Adverse selection costs are often contingent on ex post publicly observable and contractible state variables such as exchange rates. In such cases, debt contracts are dominated by currency swaps. Moreover, optimal securities are derivative contracts that are contingent on state variables that influence adverse selection costs. This is because the netting of cash flows in these derivative contracts, in effect, alters the state-by-state seniority of different claims in a desirable way.

Suggested Citation

Chowdhry, Bhagwan and Grinblatt, Mark and Levine, David K., Information Aggregation, Security Design and Currency Swaps (January 2002). NBER Working Paper No. w8746. Available at SSRN: https://ssrn.com/abstract=298270

Bhagwan Chowdhry

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-5883 (Phone)
310-206-5455 (Fax)

Mark Grinblatt (Contact Author)

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-1098 (Phone)
310-206-5455 (Fax)

Yale University - International Center for Finance

Box 208200
New Haven, CT 06520-8200
United States

National Bureau of Economic Research (NBER)

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United States

David K. Levine

Washington University in St. Louis - Department of Economics ( email )

One Brookings Drive
St. Louis, MO 63130
United States

HOME PAGE: http://www.dklevine.com

European University Institute - Robert Schuman Centre for Advanced Studies (RSCAS) ( email )

Villa La Fonte, via delle Fontanelle 18
50016 San Domenico di Fiesole
Florence, Florence 50014
Italy

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