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Adverse selection and security design

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  • Rohit Rahi
Abstract
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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Suggested Citation

  • 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

    as
    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. David M. Frankel & Yu Jin, 2015. "Securitization and Lending Competition," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 82(4), pages 1383-1408.
    2. 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.
    3. Dimitri Vayanos & Jiang Wang, 2012. "Liquidity and Asset Returns Under Asymmetric Information and Imperfect Competition," The Review of Financial Studies, Society for Financial Studies, vol. 25(5), pages 1339-1365.
    4. Arnold, Lutz G. & Zelzner, Sebastian, 2022. "Financial trading versus entrepreneurship: Competition for talent and negative feedback effects," The Quarterly Review of Economics and Finance, Elsevier, vol. 86(C), pages 186-199.
    5. 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.
    6. 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.
    7. Luis Angel Medran & Xavier Vives, 2004. "Regulating Insider Trading When Investment Matters," Review of Finance, European Finance Association, vol. 8(2), pages 199-277.
    8. 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.
    9. García, Diego & Urošević, Branko, 2013. "Noise and aggregation of information in large markets," Journal of Financial Markets, Elsevier, vol. 16(3), pages 526-549.
    10. 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.
    11. 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.
    12. Mark Grinblatt & Bhagwan Chowdhry & David Levine, 2002. "Information Aggregation, Security Design, and Currency Swaps," Yale School of Management Working Papers ysm38, Yale School of Management.
    13. Marín, José & Rahi, Rohit, 1997. "Speculative securities," LSE Research Online Documents on Economics 119175, London School of Economics and Political Science, LSE Library.
    14. Rossen Valkanov & Andra Ghent, 2014. "Complexity in Structured Finance: Financial Wizardry or Smoke and Mirrors," 2014 Meeting Papers 104, Society for Economic Dynamics.
    15. Jin, Yu, 2012. "Essays on financial institutions and instability," ISU General Staff Papers 201201010800003361, Iowa State University, Department of Economics.
    16. Rahi, Rohit & Zigrand, Jean-Pierre, 2018. "Information acquisition, price informativeness, and welfare," Journal of Economic Theory, Elsevier, vol. 177(C), pages 558-593.
    17. 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).
    18. Liu, Luke, 2011. "Securitization and moral hazard: Does security price matter?," MPRA Paper 35004, University Library of Munich, Germany.
    19. 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.
    20. Juan Hatchondo, 2004. "The value of information with heterogeneous agents and partially revealing prices," Econometric Society 2004 North American Summer Meetings 175, Econometric Society.
    21. Rahi, Rohit & Zigrand, Jean-Pierre, 2018. "Information acquisition, price informativeness and welfare," LSE Research Online Documents on Economics 118935, London School of Economics and Political Science, LSE Library.

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