Dynamic Asset-Backed Security Design

63 Pages Posted: 14 Aug 2018 Last revised: 22 Apr 2021

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: Feburary 14, 2021

Abstract

Borrowers obtain liquidity by issuing securities backed by current period payoff and resale price of a long-lived collateral asset. They are privately informed about the payoff distribution. Asset price can be self-fulfilling: higher asset price lowers adverse selection, allows borrowers to raise more 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. Persistence in adverse selection lowers debt funding, generates volatility in asset price, and exacerbates credit crunch. The theory demonstrates the role of asset-backed securities on the 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

Ozdenoren, Emre and Yuan, Kathy Zhichao and Zhang, Shengxing, Dynamic Asset-Backed Security Design (Feburary 14, 2021). 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
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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
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+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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