Liquidity, Default, Taxes and Yields on Municipal Bonds

Abstract

We examine the relative yields of Treasuries and municipals using a generalized model that includes liquidity as a state factor. Using a unique transaction dataset, we are able to estimate the liquidity risk of municipals and its effect on bond yields. We find that a substantial portion of the maturity spread between long-and short-maturity municipal bonds is attributable to the liquidity premium. Controlling for the effects of default and liquidity risk, we obtain implicit tax rates very close to the statutory tax rates of high-income individuals and corporations, and these tax rate estimates are remarkably stable over maturities.

Three essays on property and liability insurance company investment

“…For the liquidity cost measures, the average of the Amihud measure is 24% on a $ 1million trade and median roundtrip cost is 0.68%, which is relative higher but comparable to Schwert 2017 In terms of the control variables, we find that the percentage of par value held by P&C insurers with the findings from Longstaff, Mithal and Neis (2005) and Wang et al (2008). It supports the argument made by Schwert (2017) that long-maturity bonds facing a higher transaction cost.…”

“…Note that Schwert 2017 illiquid. 78 The average yield in Wang et al (2008)'s sample for years 2000-2004 is 3.88%, and the liquidity spread accounts for 9% to 19% of total yields.…”

“…Our paper contributes and is related to the literature on the determinants of the yield spread of municipal bonds. Wang, Wu and Zhang (2008) and Ang, Bhansali and Xing (2010) examine the default risk, liquidity risk and tax component of municipal bond yield spread, and find that all three components are priced. Longstaff (2011) demonstrates that tax risk is a systematic asset pricing factors and it helps resolve the muni-bond puzzle.…”

Modeling Municipal Yields With (and Without) Bond Insurance

“…He finds that these municipal yields display the same tendency to be too high relative to Treasury yields, concluding that default risk does not explain the muni puzzle. Wang et al (2008) introduce default and liquidity components into Green's model and show that the estimated tax rate is stable across maturity and credit rating. command a somewhat larger liquidity discount than uninsured bonds, and that this difference results in the so-called "yield inversion" at the end of our sample period, when some of the monolines are nearly bankrupt and the default components of insured and uninsured bonds become more or less equalized.…”

Municipal Debt and Marginal Tax Rates: Is There a Tax Premium in Asset Prices?

“…4 4 Other important research on municipal debt markets includes Yawitz, Maloney, and Ederington (1985), Green (1993), Green and Oedegaard (1997), Chalmers (1998), Downing and Zhang (2004), Nanda and Singh (2004), Green (2007), Green, Hollifield, and Schürhoff (2007a, 2007b), Green, Li, and Schürhoff (2007), Wang, Wu, and Zhang (2008), and Ang et al (2010). Important papers addressing the impact of taxation on bond prices and trading strategies include Livingston (1979), Constantinides and Ingersoll (1982), Schaefer (1982), Litzenberger and Rolfo (1984), Jordan (1984), Dybvig and Ross (1986), Dammon and Green (1987), Graham (2003), and Dammon, Spatt, and Zhang (2004). …”