Despite their high-risk profile and low likelihood of repayment, U.S. corporate bonds remain actively traded after default. We document that upon default intermediation shifts to dealers with expertise in trading the bond. These primary dealers locate higher-valuation counterparties, participate in longer intermediation chains, absorb more order flow in their inventory, and provide more efficient pricing than other dealers. The switch to trading with primary dealers raises recovery rates by 10%. Our results highlight the importance of dealers’ expertise, coupled with their ability to connect with specialized investors, which contributes to stabilizing distressed bond markets and mitigating corporate credit risk.

We model financial innovations such as Exchange-Traded Funds, smart beta products, and many index-based vehicles as composite securities (CSs) that facilitate trading the common factors in assets’ liquidation values. Through accessing a larger basket of assets in endogenously chosen proportions, CSs reduce investors’ duplication of effort in trading multiple securities and attract more factor investors. We characterize analytically how competitive CS designers in equilibrium optimally select liquid underlying assets representative of the factors and find corroborating evidence in ETF data. CS trading entails investors’ strategic and active decisions, consequently impounding more systematic information into prices. Their rise creates leads to greater informational efficiency, price variability, and co-movements in the underlying asset markets, as well as potentially heterogeneous effects on liquidity and asset-specific information acquisition/incorporation, depending on the importance of factors for asset value. The predictions explain and reconcile the rich (and often mixed) empirical observations about various types of CSs in the extant literature.

We study a credit contract that includes a contractually binding costly savings period. Defaulting during the savings period involves a sizable penalty. We show theoretically that costly savings act as a device to signal borrowers’ high-quality, expanding access to credit and dominate classic credit contracts in the presence of information asymmetry and liquidity constraints. We empirically study such a contract in Brazil – Consorcio –

and provide empirical support for the theory’s prediction. While Consorcio participants appear riskier on observables, default rates in Consorcios are lower. Furthermore, we exploit a reform reducing the cost of signaling during the savings period and find that a lower signaling cost induces adverse selection in Consorcio relative to bank loans. Similar contracts exist around the world, including credit builder loans in the US. Overall, our paper explores a new contract-design mechanism to mitigate information asymmetry problems.