Domestic primary dealers’ disclosure and peer banks’ asset allocation decisions: Evidence from sovereign debt classification

ABSTRACT Primary dealers are sophisticated investors appointed by sovereign issuers to buy, promote, and distribute sovereign debt that develop a deep knowledge of sovereign debt markets. This study examines domestic primary dealers’ sovereign debt classification, which is presumed to reflect their superior information sets on expected sovereign yields. We hypothesize that when this classification is disclosed in financial statements, peer banks adjust their asset allocation accordingly. We first document the predictive ability of domestic primary dealers’ sovereign debt classification for future sovereign yields. Next, using a sample of 6,437 bank-year observations over the 2012–2019 period and after controlling for publicly available information and other determinants of banks’ asset allocation decisions, we show that peer banks divest financial instruments and increase loans when domestic primary dealers disclose more sovereign debt at amortised cost. These effects are more pronounced among peer banks facing greater informational disadvantages.