Obscure Contract Terms: An Inadvertent Pricing Experiment

Document Type

Article

Publication Date

7-2024

DOI

https://doi.org/10.1093/cmlj/kmae011

Abstract

Bonds and other tradable securities are issued pursuant to detailed, lengthy contracts that govern investors’ legal rights. These are largely standardized, form contracts, but the fine print can vary. From first principles, it seems that market prices should be sensitive to differences in the underlying contract, at least when those differences impact investors’ legal rights. In markets that tend towards efficiency, the price of a security should incorporate public information about the security and its issuer. For example, if two securities are otherwise identical, but one confers contractual rights that might prove valuable in a default, one would expect investors to assign greater value to the more protective security. One should particularly expect that effect to manifest itself for riskier securities and as default becomes more likely. If this does not happen, it creates an arbitrage opportunity for sophisticated investors, whose trades should move the market towards efficiency.

Disciplines

Banking and Finance Law | Contracts | Law | Marketing Law

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