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Liquid Bundles

  • Farhi, Emmanuel
  • Tirole, Jean

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.

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Paper provided by Institut d'Économie Industrielle (IDEI), Toulouse in its series IDEI Working Papers with number 736.

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Date of creation: Jul 2012
Date of revision: Oct 2013
Handle: RePEc:ide:wpaper:26064
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  1. Subrahmanyam, Avanidhar, 1991. "A Theory of Trading in Stock Index Futures," Review of Financial Studies, Society for Financial Studies, vol. 4(1), pages 17-51.
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  7. Kyungmin Kim & Benjamin Lester & Braz Camargo, 2012. "Subsidizing Price Discovery," 2012 Meeting Papers 338, Society for Economic Dynamics.
  8. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
  9. Armstrong, Mark & Vickers, John, 2006. "Competitive nonlinear pricing and bundling," MPRA Paper 70, University Library of Munich, Germany.
  10. Cremer, J. & Khalil, F., 1991. "Gathering Information Before Signing a Contract," Discussion Papers in Economics at the University of Washington 91-16, Department of Economics at the University of Washington.
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  17. Peter M. DeMarzo, 2005. "The Pooling and Tranching of Securities: A Model of Informed Intermediation," Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 1-35.
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  19. Abhijit V. Banerjee & Eric S. Maskin, 1996. "A Walrasian Theory of Money and Barter," The Quarterly Journal of Economics, Oxford University Press, vol. 111(4), pages 955-1005.
  20. Spiegel, Matthew, 1998. "Stock Price Volatility in a Multiple Security Overlapping Generations Model," Review of Financial Studies, Society for Financial Studies, vol. 11(2), pages 419-47.
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  22. Steven Shavell, 1994. "Acquisition and Disclosure of Information Prior to Sale," RAND Journal of Economics, The RAND Corporation, vol. 25(1), pages 20-36, Spring.
  23. Stewart C. Myers & Nicholas S. Majluf, 1984. "Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have," NBER Working Papers 1396, National Bureau of Economic Research, Inc.
  24. Dang, Tri Vi, 2008. "Bargaining with endogenous information," Journal of Economic Theory, Elsevier, vol. 140(1), pages 339-354, May.
  25. Armstrong, Mark, 2012. "A more general theory of commodity bundling," MPRA Paper 37375, University Library of Munich, Germany.
  26. Guillaume Plantin, 2009. "Learning by Holding and Liquidity," Review of Economic Studies, Oxford University Press, vol. 76(1), pages 395-412.
  27. Gorton, Gary & Pennacchi, George, 1990. " Financial Intermediaries and Liquidity Creation," Journal of Finance, American Finance Association, vol. 45(1), pages 49-71, March.
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