Dynamic Coordination with Flexible Security Design
56 Pages Posted: 14 Aug 2018 Last revised: 25 Jun 2019
Date Written: June 24, 2019
Borrowers obtain funding for production by issuing securities backed by the current-period div- idend and resale price of a long-lived collateral asset. Borrowers are privately informed about the collateral quality. A higher (lower) resale price lowers (increases) adverse selection and makes the as- set a good (lousy) collateral. Conversely, good (lousy) collateral has a high (low) resale price. When only equity is issued, this dynamic feedback between the asset price and collateral quality can lead to multiple equilibria. Optimal flexible security design eliminates multiple equilibria fragility and improves welfare through intertemporal coordination. When the security design is rigid, multiple equilibria reemerge.
Keywords: Liquidity; Security Design; Financial Fragility; Repo
JEL Classification: G10; G01
Suggested Citation: Suggested Citation