Default Risk Cannot Explain the Muni Puzzle: Evidence from Municipal Bonds That are Secured by U.S. Treasury Obligations

Fama (1977) and Miller (1977) predict that one minus the corporate tax rate will equate after-tax yields from comparable taxable and tax-exempt bonds. Empirical evidence shows that long-term tax-exempt yields are higher than theory predicts. Two popular explanations for this empirical puzzle are tha...

Full description

Saved in:
Bibliographic Details
Published in:The Review of financial studies 1998-07, Vol.11 (2), p.281-308
Main Author: Chalmers, John M. R.
Format: Article
Language:English
Subjects:
Arbitrage
Bonds
Call options
Capital gains
Corporate taxes
Credit risk
Default
Estimated taxes
Financial economics
Financial instruments
Government bonds
Municipal bonds
Put & call options
Risk
Stock returns
Tax exempt bonds
Tax exemptions
Tax rates
Taxable bonds
Treasuries
U.S.A
Yield
Yield to maturity
Citations: Items that this one cites
Items that cite this one
Online Access:Get full text
Tags: Add Tag
No Tags, Be the first to tag this record!
Description
Summary:Fama (1977) and Miller (1977) predict that one minus the corporate tax rate will equate after-tax yields from comparable taxable and tax-exempt bonds. Empirical evidence shows that long-term tax-exempt yields are higher than theory predicts. Two popular explanations for this empirical puzzle are that, relative to taxable bonds, municipal bonds bear more default risk and include costly call options. I study U.S. government secured municipal bond yields which are effectively default-free and noncallable. These municipal yields display the same tendency to be too high. I conclude that differential default risk and call options do not explain the municipal bond puzzle.
ISSN:0893-9454
1465-7368
DOI:10.1093/rfs/11.2.281