Dynamic Asset-Backed Security Design

52 Pages Posted: 14 Aug 2018 Last revised: 25 Jan 2019

See all articles by Emre Ozdenoren

Emre Ozdenoren

London Business School; Centre for Economic Policy Research (CEPR)

Kathy Yuan

London School of Economics & Political Science (LSE) - Department of Finance

Shengxing Zhang

London School of Economics (LSE) - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: January 18, 2019

Abstract

We study a dynamic problem of the design and sale of securities backed by a long-lived collateral asset. Issuers are privately informed about the quality of the asset and raise capital by securitizing it. Issuers can pledge not only the current period payoff from the assets but also the future resale price. There is a dynamic feedback loop between the future asset price and today's collateral quality: An asset that is a good (lousy) collateral has high (low) resale price, but high (low) resale price makes an asset a good (lousy) collateral. Multiple dynamic - liquid and illiquid - equilibria might arise when only equity contracts can be issued. We characterize the optimal security design and demonstrate that it involves short-term liquid collateralized debt. It eliminates the multiple equilibria fragility and improves social welfare relative to the illiquid equity equilibrium. When the security contract is not flexible, runs might occur through the dynamic feedback loop. Comparative statics generate rich dynamic properties of haircuts and interest rates as well as runs in relation to adverse selection and default risk.

Keywords: Liquidity; Security Design; Financial Fragility; Repo

JEL Classification: G10; G01

Suggested Citation

Ozdenoren, Emre and Yuan, Kathy Zhichao and Zhang, Shengxing, Dynamic Asset-Backed Security Design (January 18, 2019). Available at SSRN: https://ssrn.com/abstract=3216085 or http://dx.doi.org/10.2139/ssrn.3216085

Emre Ozdenoren

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Kathy Zhichao Yuan

London School of Economics & Political Science (LSE) - Department of Finance ( email )

Old Building
Houghton Street
London, London WC2A 2AE
United Kingdom
+44 (0)20 7955 6407 (Phone)
+44 (0)20 7849 4647 (Fax)

HOME PAGE: http://fmg.lse.ac.uk/~kathy

Shengxing Zhang (Contact Author)

London School of Economics (LSE) - Department of Economics ( email )

Houghton Street
London WC2A 2AE
United Kingdom

HOME PAGE: http://https://sites.google.com/site/oo7zsx/

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