Information Spillovers and Sovereign Debt: Theory Meets the Eurozone Crisis

We develop a theory of information spillovers in sovereign bond markets in which investors can acquire information about default risk before trading in primaryand secondary markets. If primary markets are structured as multi-unitdiscriminatory-price auctions, an endogenous winner’s curse leads to strategiccomplementarities 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 withthe behavior of primary and secondary market yields, market segmentation, and measures of information acquisition during the Eurozone sovereign debt crisis.