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Adverse Selection and Security Design

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  • Rahi, Rohit

Abstract

This paper studies the problem of optimal security design by a privately informed entrepreneur. In the context of a simple parametric model, it is shown that the entrepreneur does not find it profitable to float an asset that affords her an informational advantage. The reason is that, with rational, uninformed outside investors, the entrepreneur faces adverse selection in the security market, which prevents her from exploiting her position as an insider. This is true whether or not she has market power in trading the asset. Copyright 1996 by The Review of Economic Studies Limited.

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Bibliographic Info

Article provided by Wiley Blackwell in its journal Review of Economic Studies.

Volume (Year): 63 (1996)
Issue (Month): 2 (April)
Pages: 287-300

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Handle: RePEc:bla:restud:v:63:y:1996:i:2:p:287-300

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References

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  1. Jordi Galí, 1993. "Local externalities, convex adjustment costs and sunspot equilibria," Economics Working Papers 43, Department of Economics and Business, Universitat Pompeu Fabra.
  2. Dimitri Vayanos & Diego Rodríguez, 1993. "Decentralization and the management of competition," Economics Working Papers 47, Department of Economics and Business, Universitat Pompeu Fabra.
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Citations

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Cited by:
  1. García, Diego & Urošević, Branko, 2013. "Noise and aggregation of information in large markets," Journal of Financial Markets, Elsevier, vol. 16(3), pages 526-549.
  2. Muendler, Marc-Andreas, 2005. "The Action Value of Information and the Natural Transparency Limit¤," University of California at San Diego, Economics Working Paper Series qt6qb079x5, Department of Economics, UC San Diego.
  3. Liu, Luke, 2011. "Securitization and moral hazard: Does security price matter?," MPRA Paper 35004, University Library of Munich, Germany.
  4. José M. Marín & Rohit Rahi, 1997. "Speculative securities," Economics Working Papers 223, Department of Economics and Business, Universitat Pompeu Fabra.
  5. Fulghieri, Paolo & Lukin, Dmitry, 2001. "Information production, dilution costs, and optimal security design," Journal of Financial Economics, Elsevier, vol. 61(1), pages 3-42, July.
  6. Luis Angel Medrano & Xavier Vives, 2004. "Regulating Insider Trading When Investment Matters," Review of Finance, Springer, Springer, vol. 8(2), pages 199-277.
  7. Bhagwan Chowdhry & Mark Grinblatt & David Levine, 2002. "Information Aggregation, Security Design, and Currency Swaps," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 110(3), pages 609-633, June.
  8. Rossen Valkanov & Andra Ghent, 2014. "Complexity in Structured Finance: Financial Wizardry or Smoke and Mirrors," 2014 Meeting Papers, Society for Economic Dynamics 104, Society for Economic Dynamics.
  9. Juan Carlos Hatchondo, 2005. "The value of information with heterogeneous agents and partially revealing prices," Working Paper, Federal Reserve Bank of Richmond 05-06, Federal Reserve Bank of Richmond.
  10. Frankel, David M. & Jin, Yu, 2011. "Securitization and Lending Competition," Staff General Research Papers 34868, Iowa State University, Department of Economics.
  11. Dimitri Vayanos & Jiang Wang, 2012. "Liquidity and Asset Returns under Asymmetric Information and Imperfect Competition," FMG Discussion Papers dp708, Financial Markets Group.
  12. Elyès Jouini & Clotilde Napp, 2008. "Are More Risk-Averse Agents More Optimistic? Insights from a Simple Rational Expectations Equilibrium Model," Post-Print halshs-00176630, HAL.
  13. Bhagwan Chowdhry & Mark Grinblatt & David K Levine, 2001. "Information Aggregation, Currency Swaps, and the Design of Derivative Securities," Levine's Working Paper Archive 2106, David K. Levine.
  14. Diego García & Branko Urosevic, 2004. "Noise and aggregation of information in large markets," Economics Working Papers 785, Department of Economics and Business, Universitat Pompeu Fabra.
  15. Yves Balasko & Enrique Kawamura, 2013. "Is risk good for saving? Message from the general equilibrium model," Textos para discussão 615, Department of Economics PUC-Rio (Brazil).

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