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Dynamic asset backed security design

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Borrowers obtain liquidity by issuing securities backed by current period payoff and resale price of a long lived collateral asset. They are privately informed about the payoff distribution. Asset price can be self fulfilling: higher asset price lowers adverse selection, allows borrowers to raise more funding which makes the asset more valuable, leading to multiple equilibria. Optimal security design eliminates multiple equilibria, improves welfare, and can be implemented as a repo contract. Persistence in adverse selection lowers debt funding, generates volatility in asset price, and exacerbates credit crunch. The theory demonstrates the role of asset backed securities on the stability of market based financial systems.

This talk is part of the Finance Seminars, CJBS series.

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