Market Incompleteness and Super Value Additivity: Implications for Securitization

49 Pages Posted: 7 Dec 2003

See all articles by Vishal Gaur

Vishal Gaur

Cornell University - Samuel Curtis Johnson Graduate School of Management

Sridhar Seshadri

University of Illinois at Urbana Champaign; Indian School of Business

Marti G. Subrahmanyam

New York University (NYU) - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: November 2003

Abstract

In an incomplete market economy, all claims cannot be priced uniquely based on arbitrage. The prices of attainable claims (those that are spanned by traded claims) can be determined uniquely, whereas the prices of those that are unattainable can only be bounded. We first show that tighter price bounds can be determined by considering all possible portfolios of unattainable claims for which there are bid/offer prices. We provide an algorithm to establish these bounds. We then examine how a price-taking agent can "package" new assets in order to take advantage of the incompleteness since the market places a premium on claims that improve its spanning. In particular, we prove that a firm with a new investment opportunity can maximize its value by "stripping away" the maximal attainable portion of the cash flow, for which prices are determined uniquely, and selling the balance to investors at prices that preclude arbitrage. Our framework has several applications in financial economics to problems ranging from securitization to the valuation of real options.

Keywords: Incomplete Markets, Valuation and Spanning, Securitization

JEL Classification: C61, G12, G13

Suggested Citation

Gaur, Vishal and Seshadri, Sridhar and Subrahmanyam, Marti G., Market Incompleteness and Super Value Additivity: Implications for Securitization (November 2003). EFA 2004 Maastricht Meetings Paper No. 2714. Available at SSRN: https://ssrn.com/abstract=475543 or http://dx.doi.org/10.2139/ssrn.475543

Vishal Gaur

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States

HOME PAGE: http://www.johnson.cornell.edu/faculty/profiles/Gaur/

Sridhar Seshadri

University of Illinois at Urbana Champaign ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

Indian School of Business ( email )

Hyderabad, Gachibowli 500 019
India

Marti G. Subrahmanyam (Contact Author)

New York University (NYU) - Department of Finance ( email )

Stern School of Business,
44 West 4th Street, Suite 9-68
New York, NY 10012-1126
United States
212-998-0348 (Phone)
212-995-4233 (Fax)

Register to save articles to
your library

Register

Paper statistics

Downloads
498
Abstract Views
2,512
rank
49,256
PlumX Metrics