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Adverse selection and security design

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  • Rohit Rahi

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

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 64.

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Date of creation: Jul 1993
Date of revision: Feb 1994
Handle: RePEc:upf:upfgen:64

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Web page: http://www.econ.upf.edu/

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References

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  1. Gali, J., 1992. "Local Externalities, Convex Adjustment Costs and Sunspot Equilibria," Papers, Columbia - Graduate School of Business 92-07, Columbia - Graduate School of Business.
  2. Dimitri Vayanos & Diego Rodríguez, 1993. "Decentralization and the management of competition," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 47, Department of Economics and Business, Universitat Pompeu Fabra.
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Citations

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Cited by:
  1. Bhagwan Chowdhry & Mark Grinblatt & David Levine, 2002. "Information Aggregation, Security Design and Currency Swaps," NBER Working Papers 8746, National Bureau of Economic Research, Inc.
  2. 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.
  3. 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.
  4. Dimitri Vayanos & Jiang Wang, 2012. "Liquidity and Asset Returns Under Asymmetric Information and Imperfect Competition," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 25(5), pages 1339-1365.
  5. Medrano, Luis Angel & Vives, Xavier, 2002. "Regulating Insider Trading when Investment Matters," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3292, C.E.P.R. Discussion Papers.
  6. Fulghieri, Paolo & Lukin, Dmitry, 2001. "Information production, dilution costs, and optimal security design," Journal of Financial Economics, Elsevier, Elsevier, vol. 61(1), pages 3-42, July.
  7. Rohit Rahi & José Marín, 1997. "Speculative Securities," FMG Discussion Papers, Financial Markets Group dp268, Financial Markets Group.
  8. Frankel, David M. & Jin, Yu, 2011. "Securitization and Lending Competition," Staff General Research Papers 34868, Iowa State University, Department of Economics.
  9. Diego García & Branko Urosevic, 2004. "Noise and aggregation of information in large markets," Economics Working Papers, Department of Economics and Business, Universitat Pompeu Fabra 785, Department of Economics and Business, Universitat Pompeu Fabra.
  10. García, Diego & Urošević, Branko, 2013. "Noise and aggregation of information in large markets," Journal of Financial Markets, Elsevier, Elsevier, vol. 16(3), pages 526-549.
  11. Liu, Luke, 2011. "Securitization and moral hazard: Does security price matter?," MPRA Paper 35004, University Library of Munich, Germany.
  12. Muendler, Marc-Andreas, 2005. "The Action Value of Information and the Natural Transparency Limit¤," University of California at San Diego, Economics Working Paper Series, Department of Economics, UC San Diego qt6qb079x5, Department of Economics, UC San Diego.
  13. 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.
  14. 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.
  15. Yves Balasko & Enrique Kawamura, 2013. "Is risk good for saving? Message from the general equilibrium model," Textos para discussão, Department of Economics PUC-Rio (Brazil) 615, Department of Economics PUC-Rio (Brazil).

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