Asymmetric Information and Security Design under Knightian Uncertainty

88 Pages Posted: 18 Jan 2018 Last revised: 25 Oct 2023

See all articles by Andrey Malenko

Andrey Malenko

Boston College; European Corporate Governance Institute (ECGI)

Anton Tsoy

University of Toronto - Department of Economics

Date Written: February 14, 2020

Abstract

A privately informed issuer raises project financing from an uninformed investor through a security sale. The investor faces Knightian uncertainty and evaluates each security by the worst-case cash flow distribution that justifies the security offering. In the unique equilibrium, both standard outside equity and standard debt are issued by different issuer types, providing a common foundation for two widespread financial contracts. Equity is effective in signaling the project’s positive NPV and prevalent under high uncertainty. Debt better exploits the issuer’s informational advantage when the upside is likely and usually arises when the investor knows that the NPV is positive.

Keywords: robustness, security design, asymmetric information, Knightian uncertainty, signaling

JEL Classification: D81, D82, D86, G32

Suggested Citation

Malenko, Andrey and Tsoy, Anton, Asymmetric Information and Security Design under Knightian Uncertainty (February 14, 2020). Available at SSRN: https://ssrn.com/abstract=3100285 or http://dx.doi.org/10.2139/ssrn.3100285

Andrey Malenko

Boston College

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

HOME PAGE: http://www.amalenko.com

Anton Tsoy (Contact Author)

University of Toronto - Department of Economics ( email )

150 St. George Street
Toronto, Ontario M5S3G7
Canada

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