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Orange County Bankruptcy: Financial Contagion in the Municipal Bond and Bank Equity Markets

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  • John M. Halstead
  • Shantaram Hegde
  • Linda Schmid Klein

Abstract

We examine the spillover wealth effects of the Orange County, California bankruptcy announcement in December 1994 on municipal bonds, municipal bond funds, and bank stocks. This bankruptcy is prominent because of unprecedented losses and because it was caused by a highly leveraged derivatives strategy rather than a shortage of tax revenues and excess spending. We find contagion in the bond market with significantly negative abnormal returns for municipal bond funds without direct exposure to Orange County and for non‐Orange County municipal bonds. In addition, our findings suggest the contagion spills over to the common stocks of investment and commercial banks that deal in or use derivatives; however, the equities of banks unexposed to derivatives are not affected.

Suggested Citation

  • John M. Halstead & Shantaram Hegde & Linda Schmid Klein, 2004. "Orange County Bankruptcy: Financial Contagion in the Municipal Bond and Bank Equity Markets," The Financial Review, Eastern Finance Association, vol. 39(2), pages 293-315, May.
    • Handle: RePEc:bla:finrev:v:39:y:2004:i:2:p:293-315
    DOI: 10.1111/j.0732-8516.2004.00077.x
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    4. Hattori, Takahiro & Miyake, Hiroki, 2015. "Empirical Analysis of Yield Determinants in Japan’s Municipal Bond Market: Does Credit Risk Premium Exist?," MPRA Paper 67127, University Library of Munich, Germany.

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