On the Value of Municipal Bond Insurance: An Empirical Analysis

Abstract

Using a large sample of municipal bond data from 2001 to 2010 in the U.S., this paper documents the time variation of the value of municipal bond insurance, estimated from the insured and uninsured bonds yield at issue differentials. We find that insured municipal bonds carry significant lower yields at issue compared to those of the equivalent uninsured bonds before 2008. However, this cost saving disappeared with the aftermath of the subprime credit crisis. We find that the supply of bonds and the level of market interest rates to have significant positive impacts on the time‐varying value of bond insurance. We also detect asymmetric response of these yield differentials to rises and declines of market interest rates. Economic intuition suggests that the value of municipal bond insurance is a function of business cycles but our tests support the contrary, which may be explained by the habitat preference of municipal bonds issues.

The Declining Insurance Benefit in the Municipal Bond Market

“…The first approach estimates a model of uninsured bond interest rates as a function of characteristics, subsequently computing the predicted values for insured bonds; see, for example, Cole and Officer (1981) and Kidwell, Sorensen, and Wachowicz (1987). The second approach estimates a model of both insured and uninsured bonds on a function of characteristics and an indicator for whether the bond is insured; see, for example, Braswell, Browning, and Nosari (1982), Lai and Zhang (2013), and Quigley and Rubinfeld (1991). We innovate upon the latter approach by introducing a more flexible specification that allows for time-varying changes in the gradient between credit ratings and bond value.…”

Natural Disasters and Municipal Bonds

“…This credit-enhancement scheme allows insured bonds to inherit bond insurers' credit ratings. The fraction of insured bonds peaked in 2005 at 57.3%, but then fell to 5.5% in 2011 following the collapse of bond insurers in the 2008 financial crisis (Lai and Zhang 2013). Municipal bond insurance became popular again after 2013: by 2016, 20% of GO bonds issued were insured (Cornaggia, Hund, and Nguyen 2019).…”