Social Capital and the Municipal Bond Market

Abstract

We examine the influence of social capital in the municipal bond market. Defined as the norms and networks that encourage cooperation, social capital is a social construct which captures a region’s level of altruism, trustworthiness and propensity to honor obligations. We expect that municipalities with high social capital are more trustworthy and likely to honor their debt obligations, which will result in lower bond yields. Our findings confirm that the bonds issued by municipalities located in high social capital counties exhibit lower yields compared to the municipalities located in low social capital counties. Our findings are also supported by bond prices in the secondary market, which shows that bonds from the municipalities located in high social capital regions have higher prices. Additional tests reveal that the influence of social capital is stronger for general obligation bonds, suggesting that social capital matters more for bonds where the willingness of municipalities to pay taxes is an important factor. Lastly, we document that the bonds of municipalities in high social capital areas are less likely to have insurance, suggesting that social capital may act as a substitute for bond insurance.

Keywords: Social Capital, Municipal Bonds, Bond Insurance, General Obligation Bonds