Risk Premia on Municipal Bonds

The finance literature has devoted considerable attention to the study of yields, yield spreads, and rating classification for fixed income securities. In the corporate market, authors such as Hickman [6], Johnson [7], Sloane [9], and Van Home [12] have investigated the behavior of yields and yield spreads over time. Johnson found that the yield differential, defined as the corporate yield minus the equal maturity Treasury rate, was unrelated to maturity. Van Home found that this differential widened during recessionary periods; he interpreted this to reflect either a higher default probability or greater investor risk aversion. In his important paper published in 1959, Lawrence Fisher [4] employed cross-sectional data at five points in time to relate corporate yield spreads to four key variables which serve as proxies for default and marketability risks. Pogue and Soldofsky [8] extended Fisher's approach to explain not corporate bond yield spreads but rather bond ratings. As explanatory variables, Pogue and Soldofsky chose several measures of the firm's income and debt capacity.