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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 92-07, Columbia - Graduate School of Business.
  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. Rohit Rahi & José Marín, 1997. "Speculative Securities," FMG Discussion Papers dp268, Financial Markets Group.
  2. 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).
  3. 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.
  4. Frankel, David M. & Jin, Yu, 2011. "Securitization and Lending Competition," Staff General Research Papers 34868, Iowa State University, Department of Economics.
  5. Dimitri Vayanos & Jiang Wang, 2012. "Liquidity and Asset Returns under Asymmetric Information and Imperfect Competition," FMG Discussion Papers dp708, Financial Markets Group.
  6. 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.
  7. Medrano, Luis Angel & Vives, Xavier, 2002. "Regulating Insider Trading when Investment Matters," CEPR Discussion Papers 3292, C.E.P.R. Discussion Papers.
  8. 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.
  9. Liu, Luke, 2011. "Securitization and moral hazard: Does security price matter?," MPRA Paper 35004, University Library of Munich, Germany.
  10. Bhagwan Chowdhry & Mark Grinblatt & David Levine, 2002. "Information Aggregation, Security Design and Currency Swaps," NBER Working Papers 8746, National Bureau of Economic Research, Inc.
  11. Juan Carlos Hatchondo, 2005. "The value of information with heterogeneous agents and partially revealing prices," Working Paper 05-06, Federal Reserve Bank of Richmond.
  12. 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.
  13. García, Diego & Urošević, Branko, 2013. "Noise and aggregation of information in large markets," Journal of Financial Markets, Elsevier, vol. 16(3), pages 526-549.
  14. 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.

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