Intermediation and Value Creation in an Incomplete Market: Implications for Securitization
In an incomplete market economy, all claims cannot be priced uniquely based only on arbitrage. The prices of attainable claims (those that are spanned by traded claims) can be determined uniquely, whereas the prices of unattainable claims can only be bounded. The issue we consider is whether the values of the latter claims can be enhanced by undertaking appropriate transactions in the financial markets. We investigate this question for an economy consisting of firms, investors and financial intermediaries, in the specific context of securitization of claims by the intermediary, i.e., pooling of claims issued by firms and issuance of tranches on the pool to investors. We derive conditions under which the pooling of assets creates value, and firms willingly participate in the creation of the pool. We also determine the optimal tranching strategy for the pooled claims, and show that the additional value of creating new securities depends on the degree of dissimilarity among investors. Our framework can be extended to analyze several applications in financial economics for problems ranging from the structure of venture capital firms to the valuation of real options.