Cross-Market Bond Pricing

Abstract

This paper explores the cross-market pricing implications introduced by mutual funds in a relatively isolated market-the municipal bond market. Bonds held by open-end mutual funds, whose returns are more sensitive to the stock market, exhibit higher yield spreads of up to 25 basis points. This pricing differential persists even when controlling for bond beta, bond characteristics, the fund's return sensitivity to the municipal bond market, and the characteristics of the fund's portfolio. Evidence indicates that high-beta funds tend to experience subsequent outflows, prompting the market to factor in the potential flow-induced sales of the underlying bonds.

Keywords: municipal bonds, mutual funds, cross-market beta

JEL Classification: G12, G14, G23