State Taxes, Limits to Arbitrage, and Differences in Municipal Bond Yields Across States
University of Notre Dame
September 30, 2013
State taxation of municipal bonds is a market friction that can lead to segmentation of the municipal bond market by state. I derive bounds on differences in yields across states when taxes are the only market friction. Tests indicate that, as predicted, bonds from states that tax interest on in and out-of-state bonds equally have the highest yields. There are other frictions besides state taxes that prevent integration. Bonds from states that tax in and out-of-state bonds equally should have the same yields. There are however, significant and persistent differences in yields across these states.
Number of Pages in PDF File: 63
Keywords: municipal bond, arbitrage, taxes, financial crisis
JEL Classification: G12, G14, G18, H70, H74
Date posted: September 30, 2013
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