Liquidity, default, taxes and yields on municipal bonds

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Federal Reserve Board, Divisions of Research & Statistics and Monetary Affairs, 2005 - Business & Economics - 51 pages
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The authors examine the relative yields of Treasuries and municipals using a generalized model that includes liquidity as a state factor. Using a unique transaction dataset, they estimate the liquidity risk of municipals and its effect on bond yields. They find that a substantial portion of the maturity spread between long- and short-maturity municipal bonds is attributable to the liquidity premium. Controlling for the effects of default and liquidity risk, they obtain implicit tax rates very close to the statutory tax rates of high-income individuals and corporations, and these tax rate estimates are remarkably stable over maturities.

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