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Journal Article
Auction-rate fireworks: Ooh, aah, ouch
Once a useful and sophisticated tool for cheap financing, issuers discover the dark side of more exotic bonds.
Newsletter
Tempestuous municipal debt markets: Oxymoron or new reality?
Municipal bonds (munis) are issued by states, cities, or other local government agencies. They may be general obligations of the issuer or secured by specified revenues, like fees paid by tollway users. The interest on municipal bonds is usually exempt from federal income taxes. Investors have long regarded these bonds as a relatively safe investment. Not coincidentally, holdings of municipal securities (or munis) have been heavily concentrated among household investors, who own about two-thirds of the $2.9 trillion market.
Journal Article
California bonds--after Prop. 13
Working Paper
Tax-exempt bonds really do subsidize municipal capital!
The traditional view of municipal finance holds that the federal tax-exemption of interest payments by state and local (municipal) governments provides a capital cost subsidy to municipal investment equal to the difference between interest rates on taxable and tax-exempt bonds. Recently, a new view has emerged which argues that tax-exemption plays a minor role, if any, in shaping municipal investment decisions. According to this new view, communities will use tax finance at the margin except in the unusual case where only debt finance is used. Thus, tax-exemption is an intramarginal (lump ...
Working Paper
Dealer Networks
Dealers in over-the-counter securities form networks to mitigate search frictions. The audit trail for municipal bonds shows the dealer network has a core-periphery structure. Central dealers are more efficient at matching buyers and sellers than peripheral dealers, which shortens intermediation chains and speeds up trading. Investors face a tradeoff between execution speed and cost. Central dealers provide immediacy by pre-arranging fewer trades and holding larger inventory. However, trading costs increase strongly with dealer centrality. Investors with strong liquidity need trade with ...
Working Paper
Liquidity, default, taxes and yields on municipal bonds
We examine the relative yields of Treasuries and municipals using a generalized model that includes liquidity as a state factor. Using a unique transaction dataset, we are able to estimate the liquidity risk of municipals and its effect on bond yields. We find that a substantial portion of the maturity spread between long- and short-maturity municipal bonds is attributable to the liquidity premium. Controlling for the effects of default and liquidity risk, we obtain implicit tax rates very close to the statutory tax rates of high-income individuals and corporations, and these tax rate ...
Journal Article
Do municipal bond yields forecast tax policy?
During the recent flat tax debate, interest rates on long-term municipal bonds rose relative to the rate on U.S. Treasury bonds. This was widely attributed to expectations of a reduction in future tax rates. While an axiom of finance states that current asset prices reflect expectations about future events, there is no consensus on how sensitive municipal bond yields are to expectations about future tax rates. This study assesses that question by examining the relationship between the implicit tax rate and actual future tax rates.> Efficient markets theory predicts that the implicit tax ...
Report
Liquidity in U.S. fixed income markets: a comparison of the bid-ask spread in corporate, government and municipal bond markets
We examine the determinants of the realized bid-ask spread in the U.S. corporate, municipal and government bond markets for the years 1995 to 1997, based on newly available transactions data. Overall, we find that liquidity is an important determinant of the realized bid-ask spread in all three markets. Specifically, in all markets, the realized bid-ask spread decreases in the trading volume. Additionally, risk factors are important in the corporate and municipal markets. In these markets, the bid-ask spread increases in the remaining-time-to maturity of a bond. The corporate bond spread also ...
Working Paper
The determinants of commercial bank holdings of municipal securities: 1985-1988
This paper presents an empirical analysis of commercial bank holdings of municipal securities (munis) from June 1985 through December 1988, using the FFIEC's Reports of Condition and income. While motivated by previous analyses suggesting that a shift from munis to taxable securities is a primary determinant of the overall impact of the Tax Reform Act of 1986 on bank profitability, this paper does not directly analyze the impact of that legislation. However, the paper modifies the specification of muni demand employed in previous analyses to consider roles for state pledging requirements, ...