Informationall insensitive debt

[shanlane]

Hello,

The idea that a security is informationally insensitive is straight forward enough (treasuries, some AAA rated securities, etc). What I do not understand, is how a deposit in a bank is considered informationally insensitive debt. This "debt" is not directly sold to the public (maybe in the form of bank CDs?). Then I would think that the CDs are the informationally insensitive instruments.

Thanks!

Shannon

 

[David Harper CFA FRM]

Hi Shannon,

Great point. I personally do not find Gorton's concept of "informationally insensitive debt" to be straightforward. The first year FRM assigned it, i thought it was brilliant etc, but each year since it slowly unravels in my head. So I surely do not have a glib or certain answer. (I am influenced by Felix Salmon's Why informationally insensitive debt is not a good thing, who btw I think is the world's top finance blogger, is why i have this tagged)

I interpret Gorton's informationally insensitive debt as, for example: If I sell you the debt instrument, determination of the price tag would require little/no research (effort) from either of us; i.e., debt with a price tag that is effortless and trusted by both of us. If this is true, it cannot be a subjective feature of buyers/sellers (if the price varied by buyer/seller too much, that implies sensitivity to market information), but an objective feature of the instrument. Under this view, cash (currency) is ultimately information insensitive and "proximity" to cash would be the test. (And, while not debt, gold and other commodities would also meet the test: the price of gold may be volatile, but we can effortlessly trust today's price). Then it gets tricky for me, because information sensitivity arguably intersects with liquidity; I'd almost argue the concept is near to liquidity --> it seems impossible to conceive of an illiquid debt which is informationally insensitive.

Under my (perhaps mistaken) interpretation that insensitive debt has an effortless and trusted price tag, all of the following are relatively insensitive: demand deposits, certificates of deposit (CD), savings account, Treasuries ... b/c they are near enough to cash ... note that my definition does not require the debt be risk-free or almost, as some do interpret Gorton: mine allows for price volatility.

Gorton loses me a little when he claims that any structured securities can ever be info insensitive, I don't see that. He somewhere I think asserts that some AAA-rated ABS are insensitive, even after the crisis, because they didn't experience defaults. True enough, but i don't think that acknowledges the lesson of the crisis the PRICE (market) risk of AAA tranches can plummet even without direct threat to their credit risk (his thematic point is that repo collateral was insensitive before it become sensitive; but senior tranches, being leveraged, are always market value-sensitive to information...) ... sorry i'm not crisp myself on this, perhaps somebody else can do better? Thanks,

 

[shanlane]

As long as I know I am not missing something relatively straight forward I am OK with it.

Just seems like someone decided to make it sound needlessly complicated. I think the AAA/info-insensitive idea goes back to the comparison of how anything with zero risk (cash, treasuries, etc) could tech be seen as info insensitive. If AAA bonds were backed by Gov't guarantee, they would fall under this umbrella.

Thanks!

Shannon

 

[David Harper CFA FRM]

Right, and your equivalency to riskfree might be the best shorthand. However, I see it as a little different than risk-free. Gorton's context is repo collateral, and before the crisis he seems to classify several risky asset-backed security types as relatively information-insensitive. What qualifies them is a lack of a need to deeply research the security (i.e., "effortless trusted price tag," is my shorthand).

His analogy is electricity. Mine might be gold (gold that meets the commodity specifications). Gold has (considerable) price risk, i don't think it's nearly risk-free. Yet, i think it's relatively information insensitive: if your gold meets the contracts specs, I know the price without much trouble. Similarly AAA Treasury bonds: they have market price risk, almost no credit risk, but highly liquidity and price transparency. I'd suggest they are informationally insensitive (under Gorton's definition) due not to the lack of credit risk, but the high liquidity and price transparency. Not that I find this definition profound, I don't ... I am nearer to your view, I may be more cynical, the more i look at the term "information insensitivity" the less i know what to do with it. Thanks

 

[shanlane]

Great explanation.

Thanks!

Shannon