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Public debt management announcements under “beat-the-market” opportunities

Public debt managers auction bonds to primary dealers (PDs) who may sell them to traders in the secondary market. PDs may have an information advantage about the bond’s value. When the resulting adverse selection problem is severe, the result is a separating equilibrium in which the secondary market breaks down whenever the true bond value is high. In a pooling equilibrium, on the other hand, the purchasing offers made by traders allow PDs to extract information rents. These rents give rise to two counteracting effects. First, they create an auction premium which incentivizes the debt manager to over-issue whenever the bond value is low. This is what we call “beat-the-market” opportunities. Data for U.S. Treasury auctions show a positive relationship between the auction premium and the issuance bias. Second, the information rents motivate traders to learn the bond value. This expertise mitigates the auction premium and the issuance bias. Announcing a target debt level commits the debt manager, limits information rent, and crowds out expertise.