The Linkage between Primary- and Secondary-Markets for Eurozone Sovereign Debt: Free Flow or Bottleneck?

Posted: 27 Jan 2018 Last revised: 5 Oct 2018

See all articles by Alexander Eisl

Alexander Eisl

Vienna University of Economics and Business

Christian Ochs

Vienna University of Economics and Business - Department of Finance, Accounting & Statistics

Nikolay Osadchiy

Emory University - Goizueta Business School

Marti G. Subrahmanyam

New York University (NYU) - Department of Finance

Date Written: September 19, 2018

Abstract

In this paper, we investigate the consequences of interlinked sovereign bond markets in the Eurozone for the transmission of yields and market conditions. This linkage is established by financial intermediaries, the so-called primary dealers, who participate in sovereign bond auctions, and are also active as market makers in the secondary markets of multiple countries. We develop a model of financially constrained primary dealers that would like to buy newly issued bonds and may consider to sell a proportion of their existing inventory, while providing liquidity in the secondary market at the same time. Our model produces optimal inventory levels for the existing- and the newly issued bonds that can be related to predictable price movements around sovereign bond issuances. The optimal inventory levels depend on the cost of inventory and regulatory capital, prevalent funding conditions, and demand volatility of the existing- and the newly issued bond. We empirically analyze how market conditions, individual bond characteristics and the existence of common intermediaries affect the relation between the primary- and secondary markets in the form of predictable price changes, as well as quoted and traded volumes. We find that primary dealers tend to liquidate more liquid and more risky bonds first in order to minimize the impact of sovereign bond auctions on their liquidation cost and their portfolios. Furthermore, lower liquidity and higher risk of the auctioned bond may lead to a higher impact of sovereign bond auctions on the secondary market and, thus, on the portfolios of primary dealers. Last, funding conditions and the basis risk, i.e., hedging capacities, may also affect the ability of primary dealers to participate in these auctions.

Keywords: Eurozone, Financial Intermediation, Sovereign Bond Market

JEL Classification: G12, G15, G23, H63

Suggested Citation

Eisl, Alexander and Ochs, Christian and Osadchiy, Nikolay and Subrahmanyam, Marti G., The Linkage between Primary- and Secondary-Markets for Eurozone Sovereign Debt: Free Flow or Bottleneck? (September 19, 2018). Available at SSRN: https://ssrn.com/abstract=3110047 or http://dx.doi.org/10.2139/ssrn.3110047

Alexander Eisl

Vienna University of Economics and Business ( email )

Heiligenstadter-Strasse 46-48
Vienna, Wien A-1190
Austria

Christian Ochs (Contact Author)

Vienna University of Economics and Business - Department of Finance, Accounting & Statistics ( email )

Welthandelsplatz 1
Vienna, 1020
Austria

Nikolay Osadchiy

Emory University - Goizueta Business School ( email )

1300 Clifton Road
Atlanta, GA 30322
United States

HOME PAGE: http://www.nikolayosadchiy.com

Marti G. Subrahmanyam

New York University (NYU) - Department of Finance ( email )

Stern School of Business,
44 West 4th Street, Suite 9-68
New York, NY 10012-1126
United States
212-998-0348 (Phone)
212-995-4233 (Fax)

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