Discussion Paper Details

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Title: Disagreement and Security Design

Author(s): Juan Ortner and Martin Schmalz

Publication Date: January 2018

Keyword(s): behavioral finance, disagreement, Optimism, overconfidence, pooling, security design and tranching

Programme Area(s): Financial Economics

Abstract: We study optimal security design when the issuer and market participants agree to disagree about the characteristics of the asset to be securitized. We show that pooling assets can be optimal because it mitigates the effects of disagreement between issuer and investors, whereas tranching a cash-flow stream allows the issuer to exploit disagreement between investors. Interestingly, pooling and tranching can be complements. The optimality of debt with or without call provisions can be derived as a special case. In a model with multiple financing rounds, convertible securities naturally emerge to finance highly skewed ventures.

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Bibliographic Reference

Ortner, J and Schmalz, M. 2018. 'Disagreement and Security Design'. London, Centre for Economic Policy Research.