Working Paper: NBER ID: w30216
Authors: Harold L. Cole; Daniel Neuhann; Guillermo Ordoñez
Abstract: We develop a theory of information spillovers in sovereign bond markets in which investors can acquire information about default risk before trading in primary and secondary markets. If primary markets are structured as multi-unit discriminatory-price auctions, an endogenous winner’s curse leads to strategic complementarities in information acquisition. As a result, shocks to default risk in one country may trigger crisis episodes with widespread information acquisition, sharp increases in the level and volatility of yields in risky countries, falling yields in safe countries, endogenous market segmentation, and arbitrage profits between primary and secondary markets. These predictions are consistent with the behavior of primary and secondary market yields, market segmentation, and measures of information acquisition during the Eurozone sovereign debt crisis.
Keywords: Sovereign Debt; Information Spillovers; Eurozone Crisis; Auction Theory
JEL Codes: D44; E63; F34; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increase in default risk in one country (F65) | Higher yields in risky countries (G15) |
| Increase in default risk in one country (F65) | Lower yields in safe countries (G15) |
| Informed investors (G11) | Strategic complementarities in information acquisition (D83) |
| Information environment changes during crises (H12) | Auction prices reveal information affecting secondary market pricing (D44) |
| Shocks to default risk in one country (F65) | Crisis episodes across borders (H12) |
| Winners' curse (D44) | Lower auction prices (D44) |