Not all General Obligation Bonds Are Created Equal

Abstract

We document a comprehensive new classification of the legal structures backing municipal bonds and the effects that different legal features have on bond yields. It is a well-documented fact that investors rely on credit ratings to determine the credit risk of municipal bonds. However, rating agencies do not fully factor in the legal structures backing the bonds because measuring and testing the effects of said legal structures is inherently onerous. Since the price of risk is unusually high in this market, these flaws have important effects on yields.

Keywords: Municipal bonds, credit ratings, rating agencies, bond yields, general obligations, legal security, state law

JEL Classification: G12, G24, H74, K22, K34