Information Aggregation, Security Design, and Currency Swaps

Posted: 20 Jun 2002

See all articles by Bhagwan Chowdhry

Bhagwan Chowdhry

UCLA Anderson; Indian School of Business

Mark Grinblatt

University of California, Los Angeles (UCLA) - Finance Area; Yale University - International Center for Finance; National Bureau of Economic Research (NBER)

David K. Levine

Washington University in St. Louis - Department of Economics; European University Institute - Robert Schuman Centre for Advanced Studies (RSCAS)

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Abstract

A security design model shows that multinational firms needing to finance their operations should issue different securities to investors in different countries in order to aggregate their disparate information about domestic and foreign cash flows. However, if the firm becomes bankrupt, investors may face uncertain costs of reorganizing assets in a foreign country and thus may value foreign assets at their average value. This penalizes superior firms with low reorganization costs. Such firms minimize the adverse selection penalty by designing securities that allocate all the cash flow in bankruptcy to investors for which the adverse selection costs are the smallest given the exchange rate. We show that this sharing rule can be implemented with currency swaps because these instruments allow the priorities of claims in bankruptcy to switch depending on the exchange rate.

Suggested Citation

Chowdhry, Bhagwan and Grinblatt, Mark and Levine, David K., Information Aggregation, Security Design, and Currency Swaps. Available at SSRN: https://ssrn.com/abstract=309723

Bhagwan Chowdhry

UCLA Anderson ( email )

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Indian School of Business ( email )

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Mark Grinblatt (Contact Author)

University of California, Los Angeles (UCLA) - Finance Area ( email )

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Yale University - International Center for Finance

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David K. Levine

Washington University in St. Louis - Department of Economics ( email )

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European University Institute - Robert Schuman Centre for Advanced Studies (RSCAS) ( email )

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