I study a dynamic model of optimal funding to understand why liquid financial assets are used as collateral. Firms need to borrow to invest in risky projects with non-verifiable returns. Since projects are profitable and assets allow firms to invest in them, firms with investment opportunities value the asset more than those without them. When investment opportunities are persistent, current borrowers also value the asset more in the future and financial assets are optimally used as collateral. Assets carry liquidity and collateral premia. As liquidity increases, the liquidity premium increases while the collateral premium decreases. The asset’s debt capacity increases with liquidity.

Cecilia Parlatore  Ph.D. in Economics, New York University. Assistant Professor of Finance at New York University Stern School of Business. Her research focuses on financial intermediaries and markets and their regulation.