Financial Innovations and Issuer Sophistication in Municipal Securities Markets
AbstractWhen local governments default or file for bankruptcy, it is often because public officials misunderstood the risks associated with innovative financial products. If unsophisticated municipal bond issuers were to widely adopt a high risk financial product, this could harm taxpayers and investors, as well as destabilize the financial system. This analysis uses municipal bond issuers’ total debt outstanding as a proxy for their sophistication and investigates the relationship between sophistication and adoption of financial innovations. Using comprehensive data on securities issued between 1992 and 2012, 25 innovations are identified. Products with these features were uncommon in the 1990s, and expanded their market share after 2000. The 600 issuers that back 75 percent of the outstanding debt adopted 21 innovations for a greater fraction of their new issuance, relative to the approximately 40,000 smaller market participants. When innovation-linked debt issuance is measured relative to annual expenditures, the mid-level jurisdictions adopted innovations to a significantly greater extent than either states and sophisticated jurisdictions or unsophisticated jurisdictions. The results suggest oversight should be concentrated on mid-level local governments where past innovations have made the greatest inroads.
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Bibliographic InfoPaper provided by Federal Reserve Bank of Cleveland in its series Working Paper with number 1404.
Length: 48 pages
Date of creation: 01 Jun 2014
Date of revision:
Find related papers by JEL classification:
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
- H74 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Borrowing
- R51 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Regional Government Analysis - - - Finance in Urban and Rural Economies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2014-06-22 (All new papers)
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