Dynamic Asset-Backed Security Design
65 Pages Posted: 14 Aug 2018 Last revised: 6 Dec 2022
There are 2 versions of this paper
Dynamic Asset-Backed Security Design
Dynamic Liquidity-Based Security Design
Date Written: December 1, 2022
Abstract
Borrowers obtain liquidity by issuing securities backed by the current period payoff and resale price of a long-lived collateral asset, and they are privately informed about the payoff distribution. Asset price can be self-fulfilling: a higher asset price lowers adverse selection and allows borrowers to raise greater funding, which makes the asset more valuable, leading to multiple equilibria. Optimal security design eliminates multiple equilibria, improves welfare, and can be implemented as a repo contract. Persistent adverse selection lowers debt funding, generates volatility in asset prices and exacerbates credit crunches. The theory demonstrates the role of asset-backed securities on stability of market-based financial systems.
Keywords: Liquidity; Dynamic Price Feedback; Tradable Assets; Security Design; Multiple Equilibria; Self-fulfilling Prices; Financial Fragility; Haircut; Repo; Repo Runs; Credit Crunch; Asset-Backed Security; Collateral; Limited Commitment; Adverse Selection; Market Based Financial Intermediation
JEL Classification: G10; G01
Suggested Citation: Suggested Citation