The Design and Rating of Securities
Peter DeMarzo, University of California, Berkeley
Darrell Duffie, Stanford University

Philippe and Will produced two papers in connection with this project.

The first paper, “A Liquidity-Based Model of Security Design,” examines securitization decisions. The model considers the tension between a desire to securitize assets when higher return investments are available to the issuer versus the illiquidity associated with those assets when the public knows that the issuer hold private information about them. The results show when standard debt is optimal. They also imply that the riskiness of the debt increases with the issuer’s retention costs of the assets. The paper is forthcoming in Econometrica.

The second paper, “The Pooling and Tranching of Securities,” is solely authored by Peter DeMarzo. In it, he considers how an intermediary should sell off assets when it has private information about their values. If it has superior information, it is generally better to sell the assets individually rather than sell them in a single pool. If the intermediary can create a multi-tranch instrument, however, it may be optimal to pool and tranch. (Accepted Spring 1998.)