The Price of Safety: The Evolution of Municipal Bond Insurance Value

63 Pages Posted: 19 Oct 2018 Last revised: 12 Aug 2021

See all articles by Kimberly Cornaggia

Kimberly Cornaggia

Pennsylvania State University - Department of Finance

John Hund

University of Georgia

Giang Nguyen

Pennsylvania State University - Smeal College of Business

Date Written: August 12, 2021

Abstract

Economic theory predicts that bond insurance lowers issuers’ financing costs by resolving asymmetric information and mitigating credit risk. With comprehensive data over the last 36 years, we find increasingly diminished empirical support for these models. The value of insurance in resolving asymmetric information beyond that resolved by credit ratings and other observable characteristics is economically minimal. The average gross value of insurance ranges 4 to 14 bps when bond insurers offer Aaa-rated coverage, with the value of insurance increasing in market competition. However, this gross value becomes insignificant after 2008 when Aaa-rated insurance no longer exists due to widespread downgrades and bankruptcies of bond insurers. Evidence suggests that the lack of insurance benefit in the post-crisis period is likely attributable to the deteriorated creditworthiness of insurance companies. Examining non-interest saving explanations for the continued use of insurance in the post-Aaa insurance market, we find evidence that issuers purchase insurance out of habit (especially those with low governance quality) and for the convenience it affords in a default event, but no evidence that insurance improves secondary market liquidity.

Keywords: municipal markets; financial guaranty; insurance value; asymmetric information

JEL Classification: G01, G12, G22, H74

Suggested Citation

Cornaggia, Kimberly and Hund, John and Nguyen, Giang, The Price of Safety: The Evolution of Municipal Bond Insurance Value (August 12, 2021). Available at SSRN: https://ssrn.com/abstract=3266890 or http://dx.doi.org/10.2139/ssrn.3266890

Kimberly Cornaggia (Contact Author)

Pennsylvania State University - Department of Finance ( email )

306 Business Bldg
University Park, PA 16802
United States
814-865-2243 (Phone)
814-865-3362 (Fax)

HOME PAGE: http://directory.smeal.psu.edu/kjr15

John Hund

University of Georgia ( email )

Athens, GA 30602
United States

Giang Nguyen

Pennsylvania State University - Smeal College of Business ( email )

University Park, PA 16802
United States

HOME PAGE: http://directory.smeal.psu.edu/gxn13

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