What Does the Financial Crisis Tell Us About the Determinants of Municipal Bonds Yields

This paper performs a comprehensive analysis on the determinants of general obligation municipal bond yields and examines the impact of the recent nancial crisis on the underlying relations. Three classes of variables aect yields of municipal bonds: the economic status of the state where the bond is issued, the demographic characteristics of the state, and the nancial status of the state or the local government where the bond is issued. This paper employs several new econometric techniques, including nonparametric regressions and Gradient Boosting, to capture both nonlinearity and potential random interactions among key determinants. A systematic comparison of the relations before and after the 2008 nancial crisis shows that the economic and nancial health of local governments has become markedly more diverse since the crisis began. The relation between the municipal bond yields and the economic and nancial health of the local governments has also become stronger because of the larger dierentiation among the local governments and hence larger signal to noise ratio, as well as closer scrutiny by market participants on the economic fundamentals of municipal governments. The analysis also shows that accommodating nonlinearities and random interaction eects can signicantly enhance the predictive performance on the municipal bond yields.