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American Economic Review Vol. 115 No. 6 2025

Optimal Security Design for Risk-Averse Investors

Alex Gershkov1; Benny Moldovanu2; Philipp Strack3; Mengxi Zhang2

1 Department of Economics and the Federmann Center for the Study of Rationality, The Hebrew University of Jerusalem, and the School of Economics, University of Surrey (email: ) · 2 Department of Economics, University of Bonn (email: ) · 3 Department of Economics, Yale University (email: )

Abstract

We use the tools of mechanism design combined with the theory of risk measures to analyze how a cash-constrained owner of an asset with known, stochastic returns raises capital from a population of investors who differ in their risk aversion and budget constraints. The issuer partitions the asset’s cash flow into several asset-backed securities, one for each type of investor. The optimal partition conforms to the commonly observed practice of tranching into senior debt, junior debt, and equity. Tranching arises endogenously due to the differences in risk appetites among agents and in the budget constraints they face.

DOI
10.1257/aer.20231597
Volume
115
Issue
6
Pages
2050-2092
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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