Security Design with Interim Public Information

Abstract

We analyze a strategic security design and trading game as in Dang et al. [7] but with a generalized structure of public information arrival. In the absence of private information, optimal securities are those least affected by interim public information. We provide conditions such that all securities traded in equilibrium consist of multiple imperfect debt tranches. Endogenous tranching obtains in the absence of private information or different risk attitudes and introduces a misalignment in the security designer’s incentives: a standard debt tranche minimizes other market participants’ incentive to acquire information, but multiple leveraged debt tranches are most robust to public information arrival.