American Journal of Economics and Business Administration

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

Kenneth Daniels and Demissew Diro Ejara

DOI : 10.3844/ajebasp.2009.11.20

American Journal of Economics and Business Administration

Volume 1, Issue 1

Pages 11-20

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.

Copyright

© 2009 Kenneth Daniels and Demissew Diro Ejara. This is an open access article distributed under the terms of the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original author and source are credited.