Journal article

Portfolio Liquidity and Security Design with Private Information

Peter DeMarzo, David Frankel, Jin Jin

The Review of Financial Studies | Oxford University Press (OUP) | Published : 2021


A privately informed seller seeks to liquidate a portfolio to raise cash. Each asset’s liquidity thus depends on the impact of its sale on the value of the entire portfolio. We demonstrate the importance of cross-signaling and derive sufficient conditions for a liquidity “pecking order” that determines the order of sale. For assets backed by a common pool, liquidity naturally aligns with seniority. Finally, we extend the portfolio liquidation game to consider security design and demonstrate the optimality of pooling securities and selling senior tranches or debt secured by the pool, with retention increasing in asset quality or informational asymmetry.

University of Melbourne Researchers

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