The Role of Sectoral Demand in Influencing Tax-Exempt Bond Yields: A Reexamination

Abstract

Despite an ongoing interest and a growing number of studies, the existence of segmentation (preferred habitats) in the tax-exempt bond market remains controversial. Adding to the existing controversy are the impacts of recent tax reform legislation on the market and, consequently, on the viability of existing theories of yield determination. The present study first establishes that segmentation did exist through 1986, but that the influence of sectoral demand declined steadily throughout the 1980s. While the Tax Reform Act of 1986 resulted in a dramatic change in the pattern of sectoral demand, the results are not clear as to whether this implies an end to segmentation or simply a need to respecify the definitions of the different market segments.