The method of auctioning sovereign debt in Portugal during the 2010-2011 crisis

Around the world, governments rely on auctions to raise money from investors using one of two auction types. In a uniform auction, everyone who wins pays the same price, the marginal price of the auction. In a discriminatory auction, each investor pays what they bid. This difference in auction type has implications for how much governments borrow, how investors behave, and ultimately how stable a country’s finances are.

Drawing on detailed data from Portuguese debt auctions, the paper shows that the auction format is not neutral. In the short run, discriminatory-price auctions can look safer as they smooth government revenue and are attractive to risk-averse borrowers. But over time, this format encourages governments to over-borrow, because only the last unit of debt sold faces the lowest price. Investors anticipate this, demand higher returns, and spreads become more volatile, as observed in Portugal before its 2011 bailout. By contrast, uniform-price auctions discipline borrowing: since the lowest price applies to all debt issued, governments are more cautious.

The analysis finds that switching from discriminatory to uniform auctions is a win-win: both Portugal and its creditors are better off, with welfare gains especially large during the crisis years. In 2014, Portugal did switch from a discriminatory to a uniform price auction for long-term debt, the debt maturity most affected by the bad incentives that lead to over-borrowing.

Click here to go to the paper by Ricardo Alves Monteiro and Stelios Fourakis.