US Municipal Bond Research Articles

Reprint of: COVID-19, lockdowns, and the municipal bond market

We study how investors in the US municipal bond market price the state lockdowns announced during the coronavirus (COVID) pandemic. To begin with, we examine the extent to which state-level COVID developments influence yield spreads of municipal bonds. We find that macro-level factors are the primary determinants of municipal bond spreads during the pandemic, but state-level COVID developments also matter at the margin. For instance, a doubling of new COVID cases in a state is associated with a 2% (1.4 basis points) increase in yield spreads of municipal bonds issued in that state. Accordingly, lockdowns may decrease municipal bond spreads by reducing COVID cases, but lockdowns may also increase them by reducing local economic activities. Overall, we find that yield spreads in both primary and secondary municipal bond markets increase by about 15% following lockdown announcements, suggesting that lockdown announcements increase the risk premiums investors require for holding municipal bonds.

COVID-19, lockdowns, and the municipal bond market

We study how investors in the US municipal bond market price the state lockdowns announced during the coronavirus (COVID) pandemic. To begin with, we examine the extent to which state-level COVID developments influence yield spreads of municipal bonds. We find that macro-level factors are the primary determinants of municipal bond spreads during the pandemic, but state-level COVID developments also matter at the margin. For instance, a doubling of new COVID cases in a state is associated with a 2% (1.4 basis points) increase in yield spreads of municipal bonds issued in that state. Accordingly, lockdowns may decrease municipal bond spreads by reducing COVID cases, but lockdowns may also increase them by reducing local economic activities. Overall, we find that yield spreads in both primary and secondary municipal bond markets increase by about 15% following lockdown announcements, suggesting that lockdown announcements increase the risk premiums investors require for holding municipal bonds.

Inscriptions of resilience: Bond ratings and the government of climate risk in Greater Miami, Florida

In recent years, credit rating agencies have begun to incorporate a municipality's resilience and vulnerability to climate change into their US municipal bond rating methods. Drawing on the case of Greater Miami resilience planning and Science and Technology Studies-inspired work on inscriptive devices, I investigate how this incorporation practically happens, and how it shapes the ways that Greater Miami governments attempt to govern climate risk through resilience investments. What “counts” as resilience there, I suggest, is increasingly an effect of the observational practices of rating agencies. However, the still-emergent status of resilience as an object of knowledge among rating agencies and Greater Miami governments means that resilience retains a degree of plasticity, allowing government officials and residents alike to mobilize the term for different purposes and toward different ends. In tracing the emergent relations between rating agency practice on climate risk and local government resilience investments, the paper makes two contributions to scholarship in economic and urban geography. First, it illuminates the ways that extra-local practices of expert valuation shape the local construction of environmental fixes. Second, it offers insights into how one of the key actors of the 2007–2008 financial crisis is beginning to lay the epistemic groundwork for future economic crises and inequalities in and between cities, this time as they relate to climate change impacts and a city's supposed resilience and vulnerability to them.

Integrity of the benchmark price for price testing of US municipal bonds

External financial market data institutions (vendors) may provide different prices for the same US municipal bond due to differences among market participants in perception about its market value. The valuation control function will include only selected vendors in the calculation of the consensus price, which enters as a benchmark price in the price testing process. Selection of vendors is largely driven by the valuation control function’s consideration of their valuation capabilities and their market coverage. Empirical analysis in this paper shows that additional pricing service may bring additional pricing information to the final consensus price, which may significantly alter the benchmark price and final price testing results. The approach described in this paper is in interest of any financial institution with US municipal bonds in the trading portfolio. Contribution of this paper to valuation of US municipal bonds is high because remaining literature does not explain alternative approach to measurement of additional pricing information in the benchmark price.

Green Bond Pricing: The Search for Greenium

Green bonds are a novel way to help unlock finance for investment in sustainable development. Some issuers and investors are watching this market with keen interest to see whether a green premium—or “greenium”—arises. The current consensus in the literature is that there is a detectable greenium in the secondary markets for corporate and US municipal bonds, but evidence for a greenium at issue is more difficult to detect. The authors provide a summary of the pricing literature and a description of their green municipal bond pricing analyses and then unpack these findings and offer an explanation as to why there is a difference in greenium behavior in the primary and secondary markets. TOPICS:ESG investing, Portfolio management/multi-asset allocation Key Findings • We find that there is no clear pattern in the literature as to whether or not there is a “greenium”, or green premium, although there is a stronger signal for greenium in the secondary markets. • We assert that in the US municipal bond market, this effect arises because of the way that the market is constructed, in that buying a bond at issue is less accessible to smaller investors than buying one in the secondary market. • Without a significant number of price points showing a greenium at issue, green issuers are not incentivised to price their bonds higher for fear of pricing themselves out of the market.

Green Premium in the Primary and Secondary U.S. Municipal Bond Markets

Green municipal bonds are a growing segment of the US municipal bond market. As they face increasing demand, there have been questions about the performance of green muni bonds relative to their conventional counterparts. In this paper, we perform yield curve analysis on a selection of green-labelled muni bonds that were issued at the same time as conventional muni bonds by the same issuers. We further refine this down to a pair-wise analysis to check the yield differential between pairs of bonds that are identical except for the green label. We find that there is a growing trend towards green premium in both the primary and secondary markets in both the series trend analysis and in the pair-wise analysis.

Public Sector Corruption in the U.S. States and Municipal Debt Finance: Do Local Governments Pay a Corruption Premium?

This paper demonstrates that capital markets take surrounding environments in the states into consideration when determining prices on local debt, above and beyond the underlying features of municipal bonds. We empirically show that corruption premium exists in the US municipal bond market. Local governments in more corrupt states pay higher costs for long-term borrowing in the market. Moreover, fiscal institutions that are traditionally thought to bring fiscal discipline to local governments become ineffective in the states with relatively higher levels of public sector corruption.

The changing value of the ‘green’ label on the US municipal bond market

Green bonds are seen as a key instrument to unlock climate finance. While their volume has grown steadily in recent years, the impact of the ‘green’ label on the bond market is poorly understood. Here, we investigate the differences between the yield term structures of green and conventional bonds in the US municipal bond market. We show that, although returns on conventional bonds are on average higher than for green bonds, the differences can largely be explained by the fundamental properties of the bonds. Historically, green bonds have been penalized on the municipal market, being traded at lower prices and higher yields than expected by their credit profiles. In recent years, however, the credit quality of municipal green bonds has increased and the premium turned positive. Green bonds are thus becoming an increasingly attractive investment, with scope to bridge the climate finance gap for mitigation and adaptation.

Investing in a green future

The growing green bond market reflects the financial sector's awakening to climate risk. New research examining the US municipal bond market suggests a positive green bond premium in recent years, driven by differences in credit quality. As climate-risk disclosure becomes more widespread, investors may show willingness to pay green premiums.

Asset Issuance in Over-the-Counter Markets

We model asset issuance in over-the-counter markets. Investors buy newly issued assets in a primary market and trade existing assets in a secondary market, where both markets are over the counter. We show that the level of asset issuance and its efficiency depend on how investors split the surplus in secondary market trade. If buyers get most of the surplus in secondary market trade, then sellers do not have incentives to participate in the primary market in order to intermediate assets and the economy has a low level of assets. On the other hand, if sellers get most of the surplus, buyers have strong incentives to participate in the primary market and the economy has a high level of assets. Equilibrium is inefficient for any splitting rule. The result follows from a double-sided hold-up problem in which it is impossible for all investors to take into account the full social value of an asset when trading. We propose a tax/subsidy scheme and show how it restores efficiency. We calibrate our model to match features of the US municipal bond market in order to quantify the effects of the intervention. The intervention leads to large welfare gains and, in response to a financial crisis caused by an aggregate demand shock, makes the crisis less severe and shorter relative to the economy with no intervention.

Public Disservice: the Negative Impact of Credit Ratings on US Municipal Bond Issuers

Credit rating agencies implemented a "dual ratings system" under which US municipal bond issuers are assessed more harshly that other types of issuers. This system created an artificial demand for bond insurance because the so-called monoline bond insurers were rated more leniently than the governments they insured. Using the Ambac Bond Insurance Cases, Superior Court of California Case Number CJC-08-004555, as a reference point, this paper discusses the origins of the dual ratings system and its costs to state and local government borrowers. Although the bond insurance business was a casualty of the 2007-2008 financial crisis, I find that the dual ratings system remains and that insurance is re-emerging - to the detriment of government bond issuers and their stakeholders.

A People's History of Collective Action Clauses

For two decades, collective action clauses (CACs) have been part of the official-sector response to sovereign debt crisis, justified by claims that these clauses can help prevent bailouts and shift the burden of restructuring onto the private sector. Reform efforts in the 1990s and 2000s focused on CACs. So do efforts in the Eurozone today. CACs have even been suggested as the cure for the US municipal bond market. But bonds without CACs are still issued in major markets, so reformers feel obliged to explain why they know better. Over time, a narrative has emerged to justify pro-CAC reforms. It relies on history and portrays CACs as novel solutions to previously-unappreciated coordination problems among bondholders. But this pro-CAC narrative is based on flawed premises. In this article, we trace the use of CACs in sovereign bonds during the 20th century. We show that CACs have been used for much of that time, although often in forms (such as trustee and collective acceleration clauses) that are no longer central to modern reform debates (which focus on modification clauses). Market participants have long been aware of CACs but did not view them as a necessary part of sovereign bond documentation. Indeed, we recount one episode in which sovereign debt was restructured without anyone seeming to notice that the relevant debt already included CACs. Contracts do not always include the optimal terms, and, at the margins, the sovereign debt markets might perform better if all bonds contained CACs. But if CACs are to be a central part of reform agendas, they should be defended on functional grounds rather than on contestable historical ones.

Market Segmentation and the Cost of Capital in a Domestic Market: Evidence from Municipal Bonds

We study the implications of market segmentation in a domestic setting, the US municipal bond market. A (state‐level) segmentation of this market emerges from asymmetric tax exemption. Municipal bond investors are exempt from state and local taxes on bonds issued by their own state, but not on bonds issued by other states. We demonstrate that market segmentation imposes significant costs on both issuers and investors in the form of higher yields and higher costs of financial intermediation. Our results provide insight into some well‐documented artifacts of the municipal bond market, such as high yields and the popularity of insurance.

Did Steve Forbes scare the US municipal bond market?

This paper investigates the relationship of the daily spread between taxable and municipal securities to a daily indicator of the likelihood of a tax reform that would eliminate the preference now accorded to municipal securities, the ‘flat tax.’ The probability of tax reform is proxied by the market price of the shares of Steve Forbes, a champion of the flat tax, in the Iowa Electronic Market. We find evidence that the indicator of tax reform’s prospects was correlated with a decline in the spread on five and ten-year maturity bonds, although not for 30-year maturity bonds. The correlations do not, however, survive in first-difference form, suggesting either that Forbes’ prospects did not immediately affect expectations of future tax policy, that the correlations are coincidental rather than causal, or that the decreased signal-to-noise ratio obscures a real, but small, causal relationship.