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Municipal Debt and Marginal Tax Rates: Is there a Tax Premium in Asset Prices?

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Author Info
Francis A. Longstaff
Abstract

We study the marginal tax rate incorporated into short-term tax-exempt municipal rates using a unique new data set from the municipal swap market. By applying an affine term-structure framework, we are able to identify both the marginal tax rate and the credit/liquidity spread in one-week tax-exempt rates. Furthermore, we obtain maximum likelihood estimates of the risk premia associated with these variables. The average marginal tax rate during the sample period is 41.6 percent. We find that the marginal tax rate is significantly positively related to returns in the stock and bond markets. The risk premium associated with the marginal tax rate is negative, consistent with the strong contracyclical nature of aftertax fixed-income cash flows which increase in bad states of the economy as personal income and the effective marginal tax rates applied to those cash flows decline.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14687.

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Date of creation: Jan 2009
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Handle: RePEc:nbr:nberwo:14687

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Find related papers by JEL classification:
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing
H2 - Public Economics - - Taxation, Subsidies, and Revenue

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  1. Duffie, Darrell & Singleton, Kenneth J, 1997. " An Econometric Model of the Term Structure of Interest-Rate Swap Yields," Journal of Finance, American Finance Association, vol. 52(4), pages 1287-1321, September. [Downloadable!] (restricted)
  2. Gregory R. Duffee, 2002. "Term Premia and Interest Rate Forecasts in Affine Models," Journal of Finance, American Finance Association, vol. 57(1), pages 405-443, 02. [Downloadable!] (restricted)
  3. Litzenberger, Robert H & Rolfo, Jacques, 1984. " An International Study of Tax Effects on Government Bonds," Journal of Finance, American Finance Association, vol. 39(1), pages 1-22, March. [Downloadable!] (restricted)
  4. Feenberg, D.R. & Poterba, J.M., 1991. "Which Households Own Municipal Bonds? Evidence from Tax Returns," Working papers 588, Massachusetts Institute of Technology (MIT), Department of Economics.
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  5. Chris Downing & Frank Zhang, 2004. "Trading Activity and Price Volatility in the Municipal Bond Market," Journal of Finance, American Finance Association, vol. 59(2), pages 899-931, 04. [Downloadable!] (restricted)
  6. Andrew Ang & Vineer Bhansali & Yuhang Xing, 2008. "Taxes on Tax-Exempt Bonds," NBER Working Papers 14496, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  7. Dammon, Robert M & Green, Richard C, 1987. " Tax Arbitrage and the Existence of Equilibrium Prices for Financial Assets," Journal of Finance, American Finance Association, vol. 42(5), pages 1143-66, December. [Downloadable!] (restricted)
  8. Buser, Stephen A. & Hess, Patrick J., 1986. "Empirical determinants of the relative yields on taxable and tax-exempt securities," Journal of Financial Economics, Elsevier, vol. 17(2), pages 335-355, December. [Downloadable!] (restricted)
  9. Vikram Nanda & Rajdeep Singh, 2004. "Bond Insurance: What Is Special About Munis?," Journal of Finance, American Finance Association, vol. 59(5), pages 2253-2280, October. [Downloadable!] (restricted)
  10. Stock, Duane & Schrems, Edward L, 1984. " Municipal Bond Demand Premiums and Bond Price Volatility: A Note," Journal of Finance, American Finance Association, vol. 39(2), pages 535-39, June. [Downloadable!] (restricted)
  11. Dybvig, Philip H & Ross, Stephen A, 1986. " Tax Clienteles and Asset Pricing," Journal of Finance, American Finance Association, vol. 41(3), pages 751-62, July. [Downloadable!] (restricted)
  12. Jordan, James V, 1984. " Tax Effects in Term Structure Estimation," Journal of Finance, American Finance Association, vol. 39(2), pages 393-406, June. [Downloadable!] (restricted)
  13. Livingston, Miles, 1982. "The Pricing of Municipal Bonds," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 17(02), pages 179-193, June. [Downloadable!]
  14. Daniel Feenberg & James Poterba, 2003. "The Alternative Minimum Tax and Effective Marginal Tax Rates," NBER Working Papers 10072, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  15. Ang, James & Peterson, David & Peterson, Pamela, 1985. " Marginal Tax Rates: Evidence from Nontaxable Corporate Bonds: A Note," Journal of Finance, American Finance Association, vol. 40(1), pages 327-32, March. [Downloadable!] (restricted)
  16. Francis A. Longstaff, 2004. "The Flight-to-Liquidity Premium in U.S. Treasury Bond Prices," Journal of Business, University of Chicago Press, vol. 77(3), pages 511-526, July. [Downloadable!]
  17. Jun Liu & Francis A. Longstaff & Ravit E. Mandell, 2006. "The Market Price of Risk in Interest Rate Swaps: The Roles of Default and Liquidity Risks," Journal of Business, University of Chicago Press, vol. 79(5), pages 2337-2360, September. [Downloadable!]
  18. Green, Richard C. & Hollifield, Burton & Schurhoff, Norman, 2007. "Dealer intermediation and price behavior in the aftermarket for new bond issues," Journal of Financial Economics, Elsevier, vol. 86(3), pages 643-682, December. [Downloadable!] (restricted)
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  19. Longstaff, Francis A., 2000. "The term structure of very short-term rates: New evidence for the expectations hypothesis," Journal of Financial Economics, Elsevier, vol. 58(3), pages 397-415, December. [Downloadable!] (restricted)
  20. Kidwell, David S & Trzcinka, Charles A, 1982. " Municipal Bond Pricing and the New York City Fiscal Crisis," Journal of Finance, American Finance Association, vol. 37(5), pages 1239-46, December. [Downloadable!] (restricted)
  21. Skelton, Jeffrey L, 1983. " Relative Risk in Municipal and Corporate Debt," Journal of Finance, American Finance Association, vol. 38(2), pages 625-34, May. [Downloadable!] (restricted)
  22. Constantinides, George M & Ingersoll, Jonathan E, Jr, 1982. " Optimal Bond Trading with Personal Tax: Implications for Bond Prices and Estimated Tax Brackets and Yield Curves," Journal of Finance, American Finance Association, vol. 37(2), pages 349-52, May. [Downloadable!] (restricted)
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