Portfolio Liquidity and Security Design with Private Information
AuthorDeMarzo, P; Frankel, D; Jin, J
Source TitleThe Review of Financial Studies
PublisherOxford University Press (OUP)
University of Melbourne Author/sFrankel, David
Document TypeJournal Article
CitationsDeMarzo, P., Frankel, D. & Jin, J. (2021). Portfolio Liquidity and Security Design with Private Information. The Review of Financial Studies, Forthcoming, https://doi.org/10.1093/rfs/hhaa147.
Access StatusThis item is embargoed and will be available on 2023-01-28
A privately informed seller seeks to liquidate a portfolio to raise cash. Each asset’s liquidity thus depends on the impact of its sale on the value of the entire portfolio. We demonstrate the importance of cross-signaling and derive sufficient conditions for a liquidity “pecking order” that determines the order of sale. For assets backed by a common pool, liquidity naturally aligns with seniority. Finally, we extend the portfolio liquidation game to consider security design and demonstrate the optimality of pooling securities and selling senior tranches or debt secured by the pool, with retention increasing in asset quality or informational asymmetry.
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