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Estimating the Signaling Benefits of Debt Insurance: The Case of Municipal Bonds

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  • Kidwell, David S.
  • Sorensen, Eric H.
  • Wachowicz, John M.

Abstract

This paper examines the demand for municipal bond insurance in the context of a competitive signaling equilibrium model. The study compares the pricing of new bond issues that are insured to similar issues that are not insured. The results indicate that issuers who purchase bond insurance, on average, are able to reduce their new issue borrowing cost more than enough to offset the cost of the insurance premium. Furthermore, the net benefit to the issuer increases as the underlying credit quality of the bond declines.

Suggested Citation

  • Kidwell, David S. & Sorensen, Eric H. & Wachowicz, John M., 1987. "Estimating the Signaling Benefits of Debt Insurance: The Case of Municipal Bonds," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(03), pages 299-313, September.
  • Handle: RePEc:cup:jfinqa:v:22:y:1987:i:03:p:299-313_01
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    References listed on IDEAS

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    1. Galai, Dan & Masulis, Ronald W., 1976. "The option pricing model and the risk factor of stock," Journal of Financial Economics, Elsevier, vol. 3(1-2), pages 53-81.
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    3. James H. Scott Jr., 1976. "A Theory of Optimal Capital Structure," Bell Journal of Economics, The RAND Corporation, vol. 7(1), pages 33-54, Spring.
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    6. Kane, Alex & Marcus, Alan J & McDonald, Robert L, 1984. " How Big Is the Tax Advantage to Debt?," Journal of Finance, American Finance Association, vol. 39(3), pages 841-853, July.
    7. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-275, May.
    8. Constantinides, George M, 1978. "Market Risk Adjustment in Project Valuation," Journal of Finance, American Finance Association, vol. 33(2), pages 603-616, May.
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    10. McDonald, Robert & Siegel, Daniel, 1984. " Option Pricing When the Underlying Asset Earns a Below-Equilibrium Rate of Return: A Note," Journal of Finance, American Finance Association, vol. 39(1), pages 261-265, March.
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    Cited by:

    1. Kriz, Kenneth A., 2003. "Comparative costs of negotiated versus competitive bond sales: new evidence from state general obligation bonds," The Quarterly Review of Economics and Finance, Elsevier, vol. 43(2), pages 191-211.
    2. Jayaraman Vijayakumar & Kenneth Daniels, 2006. "The Role and Impact of Financial Advisors in the Market for Municipal Bonds," Journal of Financial Services Research, Springer;Western Finance Association, vol. 30(1), pages 43-68, August.
    3. Stéphanie Serve, 2002. "Le recours au financement désintermédié par une collectivité locale et l'évaluation de la prime de risque obligataire: le cas de la ville de Marseille," Revue Finance Contrôle Stratégie, revues.org, vol. 5(2), pages 107-142, June.
    4. Gore, Angela K & Sachs, Kevin & Trzcinka, Charles, 2004. "Financial Disclosure and Bond Insurance," Journal of Law and Economics, University of Chicago Press, vol. 47(1), pages 275-306, April.
    5. Brune, Chris & Liu, Pu, 2011. "The contagion effect of default risk insurer downgrades: The impact on insured municipal bonds," Journal of Economics and Business, Elsevier, pages 492-502.
    6. Kirstein, Roland & Gerhard, Hans, 2005. "The "Rainmaker's Dilemma": Bad Debt Loss Insurance in Settlement and Litigation," CSLE Discussion Paper Series 2005-02, Saarland University, CSLE - Center for the Study of Law and Economics.

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