The Optimal Redemption Schedule of Serial Municipal Debt: A Dynamic Reconciliation of Revenues, Reinvestment Rates and the Term Structure

The purpose of our research is to develop an algorithm that optimally schedules municipal debt redemptions. It is our hypothesis that segmented investor demand, the existing term structure, the temporal behavior of municipal project revenues and reinvestment opportunities for interim revenue surpluses are all factors which should impact the optimal debt scheduling problem in a unique and economically meaningful way. For example, investor preference for shorter maturities and an upward sloping term structure of interest rates should, ceteris paribus, increase the proportion of debt scheduled to be repaid early in the redemption horizon. If investor demand is limited to a relatively small geographic area, such limited demand should be reflected in higher yields. If municipal project revenues increase over time then a larger proportion of the debt should be scheduled to be redeemed later. Unfortunately, realistic acknowledgements of the nature of the municipal debt financing problem create an objective function and a set of constraints which are far too complex to yield simple reduced form presentations of the optimal principal redemptions. Consequently, solutions to the optimal debt schedule and tests of the conjectures articulated above were simulated. Copyright 2001 by Kluwer Academic Publishers