Impact of Information Asymmetry on Municipal Bond Yields: An Empirical Analysis

Abstract

This study analyzes the differences in interest rates of GO and RV bonds. Empirical analyses show that RV bonds cost an average of 74 basis points more than the GO bonds. We hypothesize that differences in information asymmetry influence these yield differences. We use the issue spread as a proxy for information asymmetry. We argue that the higher the degree of information asymmetry, the larger the issue spread. The difference in yields between RV and GO bonds decreases to about 44 basis points when we control for external economic variables, issuer and issue characteristics, including credit rating, spread, maturity, bid type and other features. Consistent with our expectations, both credit ratings and spread have significant explanatory powers although they do not fully capture the differences between the two types of local government bonds.

Keywords: Municipal bonds, bond yields, information asymmetry, revenue bonds, General obligation bonds, credit rating

JEL Classification: G24, H72, H74