Biais, Bruno and Mariotti, Thomas (2003) Strategic liquidity supply and security design. TE, 445. Suntory and Toyota International Centres for Economics and Related Disciplines, London School of Economics and Political Science, London, UK.
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We study how securities and trading mechanisms can be designed to optimally mitigate the adverse impact of market imperfections on liquidity. Asset owners seek to obtain liquidity by selling their claims on future cash-flows, on which they have private information. Our analysis encompasses both the cases of competitive and monopolistic liquidity supply. In the optimal trading mechanism associated to an arbitrary given security, issuers with low cash-flows sell their entire holdings of the security, while issuers with larger cash-flows are typically excluded from trade. By designing the security optimally, issuers can eshew exclusion altogether. The optimal security is debt. Because of its low informational sensitivity, debt mitigates the adverse selection problem. Furthermore, by pooling all issuers with high cash-flows, debt also reduces the ability of a monopolistic liquidity supplier to exclude them from trade in order to better extract rents from issuers with low cash-flows.
|Item Type:||Monograph (Discussion Paper)|
|Additional Information:||© 2003 the authors|
|Library of Congress subject classification:||H Social Sciences > HG Finance|
|Journal of Economic Literature Classification System:||G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure
L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L14 - Transactional Relationships; Contracts and Reputation; Networks
|Sets:||Collections > Economists Online
Research centres and groups > Suntory and Toyota International Centres for Economics and Related Disciplines (STICERD)
|Date Deposited:||11 Jul 2008 14:05|
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