Abstract
This study examines the pricing of municipal bonds before and after a currency shock in Switzerland. Two approaches are used to decompose the municipal to treasuries bond spreads into liquidity, maturity, and default risk premiums. The first approach is the model of the cross-sectional instrumental variables, and the second approach is the model of the instrumental variables with panel data. This study examines the composition of spreads for both approaches, in three scenarios: before, throughout, and after the currency shock. The study performed Durbin-Wu-Hausman tests for each decisive model to verify endogeneity issues, including the Lagrangian Multiplier test, the Cragg-Donald Wald F statistic to confirm the relationship of instrumental and endogenous variables, and the structural break test (Bai-Perron test) to determine the existence of structural breaks in bond distortions. This study finds that the currency price distortions of the Swiss franc in January 2015 made long-run changes in the composition of the municipal bond spreads. This research contributes to the understanding of municipal bond pricing by showing that default risk accounts for a large portion of the municipal bond spread, while maturity risk plays a lesser role. According to our empirical findings, unexpected large currency price shocks may have long-term implications on the municipal bond spreads.
Highlights
IntroductionScholars have become increasingly interested in the field of price distortions and municipal bonds premiums
Over the last decade, scholars have become increasingly interested in the field of price distortions and municipal bonds premiums
Fiscal policy and risks arising from sudden events, price distortions, and municipal bonds premiums are affected by the monetary policy and exchange rate changes
Summary
Scholars have become increasingly interested in the field of price distortions and municipal bonds premiums. By definition, describe significant gaps between mark-to-market prices and a plausible range of economic values of certain assets. Price distortions draw mispricing of financial assets relative to their fundamental value. This phenomenon is especially pronounced in conditions caused by shocks (crisis events), affecting banks (Kou et al 2021b), companies (Kou et al 2021a; Maiti et al 2020), markets Vukovic et al Financ Innov (2021) 7:60 CHF/EUR Bid. fiscal policy and risks arising from sudden events, price distortions, and municipal bonds premiums are affected by the monetary policy and exchange rate changes. While the Swiss stock market collapsed, many mutual and hedge funds around the world realized large losses, and the 10-year Swiss treasury yield dropped some 251 bps in the same couple of days
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