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Optimal Security Design for Risk-Averse Investors

Author

Listed:
  • Alex Gershkov
  • Benny Moldovanu
  • Philipp Strack
  • Mengxi Zhang

Abstract

We use the tools of mechanism design combined with the theory of risk measures to analyze how a cash-constrained owner of an asset with known, stochastic returns raises capital from a population of investors who differ in their risk aversion and budget constraints. The issuer partitions the asset's cash flow into several asset-backed securities, one for each type of investor. The optimal partition conforms to the commonly observed practice of tranching into senior debt, junior debt, and equity. Tranching arises endogenously due to the differences in risk appetites among agents and in the budget constraints they face.

Suggested Citation

  • Alex Gershkov & Benny Moldovanu & Philipp Strack & Mengxi Zhang, 2025. "Optimal Security Design for Risk-Averse Investors," American Economic Review, American Economic Association, vol. 115(6), pages 2050-2092, June.
    • Handle: RePEc:aea:aecrev:v:115:y:2025:i:6:p:2050-92
    DOI: 10.1257/aer.20231597
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    More about this item

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets
    • G51 - Financial Economics - - Household Finance - - - Household Savings, Borrowing, Debt, and Wealth

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