Adverse Selection Dynamics in Privately-Produced Safe Debt Markets

71 Pages Posted: 21 Dec 2020 Last revised: 12 Oct 2021

See all articles by Nathan Foley-Fisher

Nathan Foley-Fisher

Board of Governors of the Federal Reserve System

Gary B. Gorton

Yale School of Management; National Bureau of Economic Research (NBER); Yale University - Yale Program on Financial Stability

Stephane Verani

Board of Governors of the Federal Reserve System

Multiple version iconThere are 3 versions of this paper

Date Written: October 12, 2021

Abstract

Privately-produced safe debt is designed so that there is no adverse selection in trade. But in some macro states, here the onset of the pandemic, it becomes profitable for some agents to produce private information, and then agents face adverse selection when they trade the debt (i.e., it becomes information-sensitive). We empirically study these adverse selection dynamics in a very important asset class, collateralized loan obligations (CLOs), which finance loans to below investment-grade firms. We decompose the bid-ask spreads on the AAA bonds of CLOs into a component reflecting dealer bank balance sheet costs and the adverse selection component.

Keywords: safe debt, adverse selection, information sensitivity, collateralized loan obligations

JEL Classification: E44, G14, G23

Suggested Citation

Foley-Fisher, Nathan and Gorton, Gary B. and Verani, Stephane, Adverse Selection Dynamics in Privately-Produced Safe Debt Markets (October 12, 2021). Available at SSRN: https://ssrn.com/abstract=3717489 or http://dx.doi.org/10.2139/ssrn.3717489

Nathan Foley-Fisher

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Gary B. Gorton (Contact Author)

Yale School of Management ( email )

165 Whitney Ave
P.O. Box 208200
New haven, CT 06511
United States

HOME PAGE: http://mba.yale.edu/faculty/profiles/gorton.shtml

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
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Yale University - Yale Program on Financial Stability

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P.O. Box 208200
New Haven, CT 06520-8200
United States

Stephane Verani

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

HOME PAGE: http://www.federalreserve.gov/econresdata/stephane-verani.htm

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