Local Political-Turnover-Induced Uncertainty and Bond Market Pricing

Abstract

Using political turnovers in mayoral appointments at the prefecture-city level in China, we show that investors in the municipal corporate bond market price their concerns for rising local political uncertainty into bonds and relocate capital toward other corporate bonds issued by local firms. Municipal/non-municipal corporate bond issue spreads increase (decrease) by 8.9 (14) basis points before the expected political turnover of mayors and reverse afterwards. The effect is more prominent for bonds issued in cities with investors who have a strong local preference, suggesting investors switch from MCBs to local non-MCBs in their bond holdings. The pricing effect is also stronger for bonds issued in regions with more developed financial markets and bonds with lower credit ratings. Lastly, bond market participants only price in the political risk induced by the turnovers of politician with direct involvement in local economic activities.