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Liquidity, default, taxes and yields on municipal bonds

  • Junbo Wang
  • Chunchi Wu
  • Frank X. Zhang
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    We examine the relative yields of Treasuries and municipals using a generalized model that includes liquidity as a state factor. Using a unique transaction dataset, we are able to estimate the liquidity risk of municipals and its effect on bond yields. We find that a substantial portion of the maturity spread between long- and short-maturity municipal bonds is attributable to the liquidity premium. Controlling for the effects of default and liquidity risk, we obtain implicit tax rates very close to the statutory tax rates of high-income individuals and corporations, and these tax rate estimates are remarkably stable over maturities.

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    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2005-35.

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    Date of creation: 2005
    Date of revision:
    Handle: RePEc:fip:fedgfe:2005-35
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