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Adverse selection and security design


  • Rohit Rahi


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.
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  • Rohit Rahi, 1993. "Adverse selection and security design," Economics Working Papers 64, Department of Economics and Business, Universitat Pompeu Fabra, revised Feb 1994.
  • Handle: RePEc:upf:upfgen:64

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    References listed on IDEAS

    1. Gali Jordi, 1994. "Local Externalities, Convex Adjustment Costs, and Sunspot Equilibria," Journal of Economic Theory, Elsevier, vol. 64(1), pages 242-252, October.
    2. Dimitri Vayanos & Diego Rodríguez, 1993. "Decentralization and the management of competition," Economics Working Papers 47, Department of Economics and Business, Universitat Pompeu Fabra.
    3. Oriol Amat, 1993. "The relationship between tax regulations and financial accounting: A comparison of Germany, Spain and the United Kingdom," Economics Working Papers 46, Department of Economics and Business, Universitat Pompeu Fabra.
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    Cited by:

    1. 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.
    2. Dimitri Vayanos & Jiang Wang, 2012. "Liquidity and Asset Returns Under Asymmetric Information and Imperfect Competition," Review of Financial Studies, Society for Financial Studies, vol. 25(5), pages 1339-1365.
    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. Bhagwan Chowdhry & Mark Grinblatt & David Levine, 2002. "Information Aggregation, Security Design, and Currency Swaps," Journal of Political Economy, University of Chicago Press, vol. 110(3), pages 609-633, June.
    5. Luis Angel Medran & Xavier Vives, 2004. "Regulating Insider Trading When Investment Matters," Review of Finance, European Finance Association, vol. 8(2), pages 199-277.
    6. Rohit Rahi & José M. Marín, 1999. "Speculative securities," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 14(3), pages 653-668.
    7. García, Diego & Urošević, Branko, 2013. "Noise and aggregation of information in large markets," Journal of Financial Markets, Elsevier, vol. 16(3), pages 526-549.
    8. 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.
    9. Chowdhry, Bhagwan & Grinblatt, Mark, 1997. "Information Aggregation, Currency Swaps, and the Design of Derivative Securities," University of California at Los Angeles, Anderson Graduate School of Management qt0js61067, Anderson Graduate School of Management, UCLA.
    10. Rossen Valkanov & Andra Ghent, 2014. "Complexity in Structured Finance: Financial Wizardry or Smoke and Mirrors," 2014 Meeting Papers 104, Society for Economic Dynamics.
    11. 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).
    12. Liu, Luke, 2011. "Securitization and moral hazard: Does security price matter?," MPRA Paper 35004, University Library of Munich, Germany.
    13. 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.
    14. Juan Hatchondo, 2004. "The value of information with heterogeneous agents and partially revealing prices," Econometric Society 2004 North American Summer Meetings 175, Econometric Society.
    15. Frankel, David M. & Jin, Yu, 2011. "Securitization and Lending Competition," Staff General Research Papers Archive 34868, Iowa State University, Department of Economics.

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