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Municipal Bonds and Tax Arbitrage: A Cointegration Analysis

Author

Listed:
  • H. Youn Kim

    (Western Kentucky University)

  • Junsoo Lee

    (University of Central Florida)

  • Stephen E. Lile

    (Western Kentucky University)

  • James R. Ramsey

    (University of Louisville)

Abstract

This article presents a new, cointegration approach to test a tax arbitrage opportunity in holding municipal bonds. Noticing that the variables of interest are nonstationary, two alternative cointegration tests are used to examine the relationship that may exist (1) between the yield on municipal bonds and the after-tax yield on corporate bonds and (2) between the explicit tax rate on corporate bonds and the implicit tax rate on municipal bonds. Previous studies do not take into account the time-series properties of the variables involved, assuming tacitly that they are stationary. Weekly bond yield data together with New Jersey and federal income tax rates are used, and various unit root and cointegration tests are employed to test for stationarity and for cointegration between the variables. The evidence fails to support the tax arbitrage hypothesis.

Suggested Citation

  • H. Youn Kim & Junsoo Lee & Stephen E. Lile & James R. Ramsey, 2000. "Municipal Bonds and Tax Arbitrage: A Cointegration Analysis," Public Finance Review, , vol. 28(4), pages 372-389, July.
    • Handle: RePEc:sae:pubfin:v:28:y:2000:i:4:p:372-389
    DOI: 10.1177/109114210002800405
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    References listed on IDEAS

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