Optimal Information and Security Design

Abstract

Abstract An asset owner designs an asset-backed security and a signal about its value. After privately observing the signal, he sells the security to the monopolistic liquidity supplier. Any optimal signal structure guarantees the security sale and commits the issuer not to learn too positive private information about the security value. The optimal security design is pure equity. It is risky debt under additional liquidity requirements akin to Basel III regulation. Thus, the standard intuition behind debt optimality as the least informationally sensitive security holds only under additional restrictions (e.g., regulatory) on security or signal design.

Keywords: security design, asymmetric information, information design

JEL Classification: D82, D86, G32