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Liquid Bundles

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  • Farhi, Emmanuel
  • Tirole, Jean

Abstract

The paper revisits and qualifies existing insights on security design. A rich literature argues that tranching creates debt-like instruments that are robust to adverse selection or discourage wasteful information acquisition. Yet, for a given information structure, while tranching confines and liquefies the safe part of a cash flow (the insulation effect), bundling makes the risky part more liquid (the trading adjuvant effect). Moreover, tranching always has adverse welfare effects on information acquisition: It encourages (discourages) information acquisition when it should be deterred (encouraged). The paper provides conditions under which tranching reduces welfare even when the insulation effect dominates the trading adjuvant effect. The paper’s second contribution is to analyze the velocity of assets that are repeatedly traded. The dynamic model can be nested into the static one and insights are shown to be closely related to those on tranching. The central insight is that liquidity is self-fulfilling: A perception of future illiquidity creates current illiquidity.

Suggested Citation

  • Farhi, Emmanuel & Tirole, Jean, 2012. "Liquid Bundles," TSE Working Papers 12-328, Toulouse School of Economics (TSE), revised Oct 2013.
    • Handle: RePEc:tse:wpaper:26065
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    References listed on IDEAS

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    Cited by:

    1. Wagner, Wolf & Uras, Burak, 2017. "Efficient Lemons," CEPR Discussion Papers 11803, C.E.P.R. Discussion Papers.
    2. Pavan, Alessandro & Vives, Xavier, 2015. "Information, Coordination, and Market Frictions: An Introduction," Journal of Economic Theory, Elsevier, vol. 158(PB), pages 407-426.

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    More about this item

    Keywords

    Liquidity; velocity; security design; tranching; information acquisition;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E51 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Money Supply; Credit; Money Multipliers
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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