Bond insurance: What is special about munis?

Vikram Nanda, Rajdeep Singh

Research output: Contribution to journalArticlepeer-review

36 Scopus citations

Abstract

Close to 50% of municipal bonds are prepackaged with insurance at the time of issue. We offer a tax-based rationale for the emergence of third-party insurance of tax-exempt bonds. We argue that insurance adds value as it allows a third party to become, in a probabilistic sense, an issuer of tax-exempt securities. Insurance however reduces value by eliminating the possibility of a capital tax loss. While the net benefit from insurance increases with bond maturity, the benefit may not increase monotonically with default risk. We also provide empirical evidence supportive of the model's predictions.

Original languageEnglish (US)
Pages (from-to)2253-2280
Number of pages28
JournalJournal of Finance
Volume59
Issue number5
DOIs
StatePublished - Oct 2004

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