Abstract
Determining a fair price and an appropriate timescale to trade municipal debt is a complex decision. This research uses data informatics to explore transaction characteristics and trading activity of investment grade US municipal bonds. Using the relatively recent data stream distributed by the Municipal Securities Rulemaking Board, we provide an institutional summary of market participants and their trading behavior. Subsequently, we focus on a sample of AAA bonds to derive a new methodology to estimate a trade-weighted benchmark municipal yield curve. The methodology integrates the study of ridge regression, artificial neural networks, and support vector regression. We find an enhanced radial basis function artificial neural network outperforms alternate methods used to estimate municipal term structure. This result forms the foundation for establishing a decision theory on optimal municipal bond trading. Using multivariate modeling of a liquidity domain measured across three dependent variables, we investigate the proposed decision theory by estimating weekly production-theoretic bond liquidity returns to scale. Across the three liquidity measures and for almost all weeks investigated, bond trading liquidity is elastic with respect to the modeled factors. This finding leads us to conclude that an optimal trading policy for municipal debt can be implemented on a weekly timescale using the elasticity estimates of bond price, trade size, risk, days-to-maturity, and the macroeconomic influences of labor in the workforce and building activity.
Highlights
Market participants believe the primary market for U.S municipal bonds is efficient for the 8 supply of funds to municipalities and state governments
Securities Rulemaking Board (MSRB) to Thomson Reuters Municipal Markets Division (MMD) we provide an institutional summary of market participants and their trading behavior
Based on the observed time-series dispersion presented in section 2, a-priori we assume the possibility of a 19 regime shift in municipal bond yields
Summary
Market participants believe the primary market for U.S municipal bonds is efficient for the 8 supply of funds to municipalities and state governments. By participant consensus, many argue this same market is widely inefficient in meeting its secondary function of promoting the price-efficient trading of municipal debt. One explanatory reason for this perceived secondary market failure is the lack of a benchmark term structure (yield) curve. The absence of a bellwether curve retards the ability of market participants to compare yields of traded bonds to a 15 generally accepted market-wide snapshot. Absent a benchmark it is all too possible that funds are trapped in the market thereby causing liquidity and pricing distortions. This characterization begs a question about whether the decision to trade securities in the U.S municipal market can be made efficiently and in a timely manner
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