Adverse Selection Dynamics in Privately-Produced Safe Debt Markets

59 Pages Posted: 21 Dec 2020

See all articles by Nathan Foley-Fisher

Nathan Foley-Fisher

Board of Governors of the Federal Reserve System

Gary B. Gorton

Yale School of Management; National Bureau of Economic Research (NBER); Yale University - Yale Program on Financial Stability

Stephane Verani

Board of Governors of the Federal Reserve System

Multiple version iconThere are 3 versions of this paper

Date Written: October 23, 2020

Abstract

Privately-produced safe debt is designed so that there is no adverse selection in trade. This is because no agent finds it profitable to produce private information about the debt's backing and all agents know this (i.e., it is information-insensitive). But in some macro states, it becomes profitable for some agents to produce private information, and then the debt faces adverse selection when traded (i.e., it becomes information-sensitive). We empirically study these adverse selection dynamics in a very important asset class, collateralized loan obligations, a large symbiotic appendage of the regulated banking system, which finances loans to below investment-grade firms.

Keywords: safe debt, adverse selection, information sensitivity, collateralized loan obligations

JEL Classification: E44, G14, G23

Suggested Citation

Foley-Fisher, Nathan and Gorton, Gary B. and Verani, Stephane, Adverse Selection Dynamics in Privately-Produced Safe Debt Markets (October 23, 2020). Available at SSRN: https://ssrn.com/abstract=3717489 or http://dx.doi.org/10.2139/ssrn.3717489

Nathan Foley-Fisher

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Gary B. Gorton (Contact Author)

Yale School of Management ( email )

165 Whitney Ave
P.O. Box 208200
New haven, CT 06511
United States

HOME PAGE: http://mba.yale.edu/faculty/profiles/gorton.shtml

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
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Yale University - Yale Program on Financial Stability

165 Whitney Avenue
P.O. Box 208200
New Haven, CT 06520-8200
United States

Stephane Verani

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

HOME PAGE: http://www.federalreserve.gov/econresdata/stephane-verani.htm

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