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Disagreement and Security Design

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  • Schmalz, Martin
  • Ortner, Juan

Abstract

We study optimal security design when the issuer and market participants agree to disagree about the characteristics of the asset to be securitized. We show that pooling assets can be optimal because it mitigates the effects of disagreement between issuer and investors, whereas tranching a cash-flow stream allows the issuer to exploit disagreement between investors. Interestingly, pooling and tranching can be complements. The optimality of debt with or without call provisions can be derived as a special case. In a model with multiple financing rounds, convertible securities naturally emerge to finance highly skewed ventures.

Suggested Citation

  • Schmalz, Martin & Ortner, Juan, 2018. "Disagreement and Security Design," CEPR Discussion Papers 12596, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:12596
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    More about this item

    Keywords

    Disagreement; Security design; Optimism; Overconfidence; Pooling; Tranching; Behavioral finance;
    All these keywords.

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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