Optimal Security Design for Risk Averse Investors (Joint with A. Gershkov, P. Strack and M. Zhang)

 

Abstract: We use the tools of mechanism design, combined with the theory of risk measures, to analyse a model where a cash constrained issuer needs to raise capital from a population of different types of risk-averse and budget constrained investors in order to finance a project with a stochastic return. To achieve her goal, the issuer partitions and sells the project's realized cash flow into several securities, one for each type of risk-averse investor. The optimal partition conforms to the commonly observed practice of "tranching" with a sequential payment structure (senior debt, junior debt and equity) where senior claims are paid before the subordinate ones. The holders of more senior/junior tranches are determined by the relative risk appetites of the different types of investors and of the issuer, with the more risk averse agents holding the more senior tranches.

 

 

 

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