Banks face a dual mandate of raising cheap deposits while avoiding liquidity risk. We propose a novel mechanism whereby banks use portfolio opacity to meet this objective. Specifically, banks choose opaque portfolios to secure cheap long-term funding while trading off insolvency and illiquidity. We show that while opacity lowers deposit rates, it also leaves depositors with only noisy information about the bank’s solvency, making them...

We study the determinants of asset market fragmentation in a model with strategic investors that disagree about the value of an asset. Investors’ choices determine the market structure. Fragmented markets are supported in equilibrium when disagreement between investors is low. In this case, investors take the same side of the market and are willing to trade in smaller markets with a higher price impact to...

The variety of financial products available for firms to raise funds has expanded rapidly in recent decades. This paper studies the role of innovations that introduce specialized financial products using a combination of granular data and a parsimonious model of security issuance. We present three key findings. First, differential product adoption across firms explains most of the observed variation in the amounts of funds raised....

The vast majority of regulatory debates about the benefits of centralized trading assume that the set of securities designed by financial intermediaries is immune to the market structure in which trade occurs. In this paper, we consider a regulator who redesigns the market structure for certain financial contracts by introducing an exchange to increase liquidity, understanding that security design is endogenous. For a given market...

We develop a theory of financial innovation in which both market structure and the payoffs of the claims being traded are determined endogenously. Intermediaries use the cash flows of an underlying asset to design securities for investors. Demand for securities arises as investors choose markets then trade using strategies represented by quantity-price schedules. We show that intermediaries create increasingly riskier asset-backed securities when facing deeper...