Optimal Security Design for Risk-Averse Investors
Alex Gershkov, Benny Moldovanu, Philipp Strack, Mengxi Zhang
American Economic Review · 2025 · Volume 115 · Issue 6
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.
Keywords
Criteria for Decision-Making under Risk and Uncertainty, Asymmetric and Private Information, Mechanism Design, Asset Pricing, Trading Volume, Bond Interest Rates, Behavioral Finance: Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets [Neurofinance], Household Finance: Household Saving, Borrowing, Debt, and Wealth
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