Do Taxes or Information Drive Demand for Bond Insurance?
26 Pages Posted: 22 Mar 2018
Date Written: September 15, 2017
I perform the first-ever test of the tax arbitrage theory of bond insurance (Nanda and Singh, 2004) using a complete dataset of all 2015 municipal bond issues. For bonds that are insured in practice, the tax-arbitrage value created by insurance is negligible and, under a realistic calibration, negative. Consistent with this fact, and contrary to the theory's predictions, taxable municipal bonds are insured as often as tax-exempt ones. Bond insurance is concentrated among small, unrated issues; for the smallest of these, the insurance premium is likely cheaper than rating agency fees. This evidence suggests that insurance creates value by producing information.
Keywords: bond, insurance, tax, information
JEL Classification: G18, G22, G28, G33, H26, H74, K34
Suggested Citation: Suggested Citation