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Assessing Municipal Bond Default Probabilities

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  • Holian, Matthew
  • Joffe, Marc

Abstract

In response to a request from the California Debt and Investment Advisory Commission, we propose a model to estimate default probabilities for bonds issued by cities. The model can be used with financial data available in Comprehensive Annual Financial Reports that cities are required to publish. The study includes modeled default probability estimates for 261 California cities with population over 25,000. Our model relies on case study evidence, logistic regression analysis of major city financial statistics from the Great Depression – the last time a large number of cities defaulted – as well as logistic regression analysis of more recent city financial statistics. Independent variables in our model include (1) the ratio of interest and pension expenses to total revenue, (2) the annual change in total revenue, (3) the ratio of general fund surplus (or deficit) to general fund revenues and (4) the ratio of general fund balance to general fund expenditures.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 46728.

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Date of creation: 30 Apr 2013
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Handle: RePEc:pra:mprapa:46728

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Keywords: municipal bonds; municipal bankruptcy; default probability model;

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  1. James Crotty, 2011. "The Realism of Assumptions Does Matter: Why Keynes-Minsky Theory Must Replace Efficient Market Theory as the Guide to Financial Regulation Policy," Working Papers wp255, Political Economy Research Institute, University of Massachusetts at Amherst.
  2. Donald B. Keim & Robert F. Stambaugh, . "Predicting Returns in the Stock and Bond Markets," Rodney L. White Center for Financial Research Working Papers 15-85, Wharton School Rodney L. White Center for Financial Research.
  3. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, vol. 25(2), pages 383-417, May.
  4. Wu, Chunchi, 1991. "A Certainty Equivalent Approach to Municipal Bond Default Risk Estimation," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 14(3), pages 241-47, Fall.
  5. Wang, Junbo & Wu, Chunchi & Zhang, Frank X., 2008. "Liquidity, default, taxes, and yields on municipal bonds," Journal of Banking & Finance, Elsevier, vol. 32(6), pages 1133-1149, June.
  6. moon, Choon-Geol & Stotsky, Janet G., 1993. "Municipal bond rating analysis : Sample selectivity and simultaneous equations bias," Regional Science and Urban Economics, Elsevier, vol. 23(1), pages 29-50, March.
  7. Hempel, George H, 1973. "Quantitative Borrower Characteristics Associated with Defaults on Municipal General Obligations," Journal of Finance, American Finance Association, vol. 28(2), pages 523-30, May.
  8. Carleton, Willard T & Lerner, Eugene M, 1969. "Statistical Credit Scoring of Municipal Bonds," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(4), pages 750-64, November.
  9. Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2004. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit-Default Swap Market," NBER Working Papers 10418, National Bureau of Economic Research, Inc.
  10. Lennox, Clive, 1999. "Identifying failing companies: a re-evaluation of the logit, probit and DA approaches," Journal of Economics and Business, Elsevier, vol. 51(4), pages 347-364, July.
  11. Burton G. Malkiel, 2003. "The Efficient Market Hypothesis and Its Critics," Journal of Economic Perspectives, American Economic Association, vol. 17(1), pages 59-82, Winter.
  12. Summers, Lawrence H, 1986. " Does the Stock Market Rationally Reflect Fundamental Values?," Journal of Finance, American Finance Association, vol. 41(3), pages 591-601, July.
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