Dealer Inventory and the Linkage between Primary and Secondary Markets for Eurozone Sovereign Debt

We study the impact of sovereign bond auctions on secondary markets and their feedback to the sovereigns’ debt cost. This linkage is established through the actions of primary dealers, participating in the auctions, and also acting as market-makers. We model financially-constrained primary dealers who buy newly issued bonds and manage their inventory, while maintaining market liquidity. We find empirical support for our model and its resulting hypotheses: primary dealers tend to liquidate more liquid and more risky bonds from their inventory in order to be able to participate in sovereign bond auctions and minimize the impact of their portfolios.