Dynamic Coordination with Flexible Security Design

56 Pages Posted: 14 Aug 2018 Last revised: 25 Jun 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: June 24, 2019

Abstract

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

Ozdenoren, Emre and Yuan, Kathy Zhichao and Zhang, Shengxing, Dynamic Coordination with Flexible Security Design (June 24, 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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