IDEAS home Printed from
MyIDEAS: Log in (now much improved!) to save this paper

Undue Diligence

Listed author(s):
  • David Andolfatto

    (Federal Reserve Bank of St. Louis)

Modern financial markets increasingly rely on complex financial products. These products often change hands even though the buyers acquire little information about the underlying structure of the financial asset. The greater the complexity of the asset structure, the more opaque it tends to be in the sense that acquiring information about the structure is difficult and thus more costly. But are these opaque assets socially beneficial? To address this question, we construct a environment in which agents trade assets that have random returns. The buyer of the asset has the opportunity to inspect the asset, at some cost, to assess its fundamental value. In short, the buyer chooses to perform due diligence or not prior to accepting the asset. We use a mechanism design approach to determine when it is socially optimal to have opaque assets. We characterize the set of allocations that satisfy sequential participation constraints for both buyers and sellers of the assets. We show that asset trade without due diligence can generate the first-best allocation if the variance of the asset return is sufficiently low or agents are sufficiently patient. This holds even if the cost of acquiring information about the asset is costless. With sufficiently high return variance or impatience, lack of due diligence can still be the optimal outcome but the first best allocation is not implementable. For sufficiently low costs of information acquisition, due diligence is optimal if the return is sufficiently variable and agents are impatient.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL:
Download Restriction: no

Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 994.

in new window

Date of creation: 2011
Handle: RePEc:red:sed011:994
Contact details of provider: Postal:
Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page:

More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

in new window

  1. Ricardo Lagos & Randall Wright, 2005. "A Unified Framework for Monetary Theory and Policy Analysis," Journal of Political Economy, University of Chicago Press, vol. 113(3), pages 463-484, June.
  2. Shouyong Shi, 1997. "A Divisible Search Model of Fiat Money," Econometrica, Econometric Society, vol. 65(1), pages 75-102, January.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:red:sed011:994. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.