Securitization, Transparency and Liquidity

We present a model of securitization where issuers of structured bonds choose coarse and opaque ratings to enhance the liquidity of their primary market, at the cost of reducing secondary market liquidity. The degree of transparency chosen by issuers is inefficiently low if the social cost of secondary market illiquidity exceeds the private one, providing a rationale for regulating the transparency of rating agencies. The model also shows that when issuers choose transparent ratings they may optimally choose to restrain the issue size, or tranche the issue so as to sell the more information-sensitive tranche to sophisticated investors only.