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Search Frictions and Product Design in the Municipal Bond Market

Author

Listed:
  • Giulia Brancaccio
  • Karam Kang

Abstract

This paper shows that product design shapes search frictions and that intermediaries leverage this channel to increase their rents in the context of the U.S. municipal bond market. The majority of bonds are designed via negotiations between a local government and its underwriter. They are then traded in a decentralized market, where the underwriter often also acts as an intermediary. Exploiting variations in state regulations that limit government officials’ conflicts of interest, we provide evidence that bond design from the government’s perspective involves a trade-off between flexibility and liquidity, but the underwriter benefits from designing and trading complex bonds. Motivated by these findings, we build and estimate a model of bond origination and trades to quantify market inefficiency driven by underwriters’ role in intermediating trades and discuss policy implications.

Suggested Citation

  • Giulia Brancaccio & Karam Kang, 2022. "Search Frictions and Product Design in the Municipal Bond Market," NBER Working Papers 30775, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:30775
    Note: IO PE POL
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    Citations

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    Cited by:

    1. Daniel Garrett & Ivan T. Ivanov, 2023. "Gas Guns and Governments: Financial Costs of Anti-ESG Policies," Working Paper Series WP 2023-07, Federal Reserve Bank of Chicago.
    2. Babus, Ana & Hachem, Kinda, 2023. "Markets for financial innovation," Journal of Economic Theory, Elsevier, vol. 208(C).
    3. Farrell, Michael & Murphy, Dermot & Painter, Marcus & Zhang, Guangli, 2023. "The complexity yield puzzle: A textual analysis of municipal bond disclosures," Working Papers 338, The University of Chicago Booth School of Business, George J. Stigler Center for the Study of the Economy and the State.
    4. Shuo Liu, 2024. "Social Optimal Search Intensity in Over-the-Counter Markets," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 53, pages 224-282, July.

    More about this item

    JEL classification:

    • L0 - Industrial Organization - - General
    • L12 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Monopoly; Monopolization Strategies
    • L15 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Information and Product Quality
    • P0 - Political Economy and Comparative Economic Systems - - General

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