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Impact of Information Asymmetry on Municipal Bond Yields: An Empirical Analysis

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  • Kenneth Daniels
  • Demissew Diro Ejara

Abstract

Problem statement: There is a significant difference between the interest rates on the GO and the RV municipal bonds. We sought explanation for this difference in differences in information asymmetry between the two types of municipal bonds. GO bonds finance general municipality expenditures and repayment is from general tax revenues. RV bonds finance special projects and repayment is from cash flows of the special projects. These projects are assumed to be more asymmetric than the general municipality tax revenues. Previous studies examined this issue but did not explicitly consider the information asymmetry differences. Approach: We used issue transaction spread as a proxy for information asymmetry. Average spread for RV bonds is 1.172% while that for GO bonds is 0.892%. We controlled for external economic factors, issue and issuer features and contractual terms that might affect yield on debt. We used two-step regression analyses to explain yields on the two types of municipal bonds. Results: RV bonds cost 74 basis points more on the average than GO bonds. After controlling for external economic factors, issue and issuer features and contract terms, the difference shrank to an average of 44 basis points. Issue transaction spread, our proxy for information asymmetry and credit rating were important determinants of bond yields. Conclusion/Recommendations: Issue transaction spread, as a proxy for information asymmetry, explained differences in bond yields. Other variables that affect yield differences were credit rating, maturity, economic activities, contract terms and other issue and issuer features. Still, there remained an unexplained difference in the yields between RV and GO bonds of 44 basis points that we left for further research. This difference was inversely related to the credit rating of the bond.

Suggested Citation

  • Kenneth Daniels & Demissew Diro Ejara, 2009. "Impact of Information Asymmetry on Municipal Bond Yields: An Empirical Analysis," American Journal of Economics and Business Administration, Science Publications, vol. 1(1), pages 11-20, March.
    • Handle: RePEc:abk:jajeba:ajebasp.2009.11.20
    DOI: 10.3844/ajebasp.2009.11.20
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    References listed on IDEAS

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    1. Allen N. Berger & Marco A. Espinosa‐Vega & W. Scott Frame & Nathan H. Miller, 2005. "Debt Maturity, Risk, and Asymmetric Information," Journal of Finance, American Finance Association, vol. 60(6), pages 2895-2923, December.
    2. Liu, Pu & Thakor, Anjan V, 1984. "Interest Yields, Credit Ratings, and Economic Characteristics of State Bonds: An Empirical Analysis: A Note," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 16(3), pages 344-351, August.
    3. Kidwell, David S & Koch, Timothy W, 1982. "The Behavior of the Interest Rate Differential between Tax-Exempt Revenue and General Obligation Bonds: A Test of Risk Preferences and Market Segmentation," Journal of Finance, American Finance Association, vol. 37(1), pages 73-85, March.
    4. Richard West, 1964. "New Issue Concessions on Municipal Bonds: A Case of Monopsony Pricing," The Journal of Business, University of Chicago Press, vol. 38, pages 135-135.
    5. Kenneth Daniels & Demissew Diro Ejara & Jayaraman Vijayakumar, 2010. "Debt Maturity, Credit Risk, and Information Asymmetry: The Case of Municipal Bonds," The Financial Review, Eastern Finance Association, vol. 45(3), pages 603-626, August.
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    Cited by:

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    2. Arti Yadav & Badar Alam Iqbal, 2021. "Socio-economic Scenario of South Asia: An Overview of Impacts of COVID-19," South Asian Survey, , vol. 28(1), pages 20-37, March.

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