Adverse Selection Dynamics in Privately-Produced Safe Debt Markets
71 Pages Posted: 21 Dec 2020 Last revised: 12 Oct 2021
Date Written: October 12, 2021
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: Suggested Citation