To Pool or Not to Pool?Security Design in OTC Markets


This paper studies the optimality of pooling and tranching for a privately informed originator who offers securities in an over-the-counter (OTC) market in which buyers have market power. Such a market scenario is particularly relevant when many of the natural counterparties face binding regulatory constraints. Contrary to the standard result that pooling and tranching are optimal practices, we find that selling assets separately may be optimal for originators, as doing so weakens buyers’ incentives to inefficiently screen them. Our results shed light on recently observed time-variation in the prevalence of pooling and tranching in financial markets.