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Explaining Municipal Bond Volatility: Implications for Practice

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  • S. Lakshmivarahan
  • Duane R. Stock

Abstract

This article explores and analyzes reasons why volatility behavior is different for different maturities and credit qualities. It models the yield volatilities of various maturities of AAA and BBB municipal bonds based on two theories of volatility. One theory is that the higher the level of interest rates, the greater the volatility. A second, more statistically complex theory, is built on the observation that periods of high volatility are caused by significant economic “news” affecting interest rates. We find that asymmetric volatility effects vary by maturity and credit quality and that there is some limited ability to predict yield changes. For example, we find strong evidence of mean reversion in yields for some maturities and credit qualities.

Suggested Citation

  • S. Lakshmivarahan & Duane R. Stock, 2006. "Explaining Municipal Bond Volatility: Implications for Practice," Municipal Finance Journal, University of Chicago Press, vol. 27(1), pages 1-33.
    • Handle: RePEc:ucp:munifj:doi:10.1086/mfj27010001
    DOI: 10.1086/MFJ27010001
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