Information Aggregation, Security Design and Currency Swaps / Bhagwan Chowdhry, Mark Grinblatt, David Levine.

Format:

Book

Author/Creator:

Chowdhry, Bhagwan.

Contributor:

National Bureau of Economic Research.

Grinblatt, Mark.

Levine, David K.

Series:

Working Paper Series (National Bureau of Economic Research) no. w8746.

NBER working paper series no. w8746

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2002.

Summary:

A model of security design based on the principle of information aggregation and alignment is used to show that (i) firms needing to finance their operations should issue different securities to different groups of investors in order to aggregate their disparate information and (ii) each security should be highly correlated (closely aligned) with the private information signal of the investor to whom it is marketed. This alignment reduces the adverse selection penalty paid by a firm with superior information. Adverse selection costs are often contingent on ex post publicly observable and contractible state variables such as exchange rates. In such cases, debt contracts are dominated by currency swaps. Moreover, optimal securities are derivative contracts that are contingent on state variables that influence adverse selection costs. This is because the netting of cash flows in these derivative contracts, in effect, alters the state-by-state seniority of different claims in a desirable way.

Notes:

Print version record

January 2002.