TAILIEUCHUNG - Fractionalization and the municipal bond market

A bond is simply a negotiable IOU, or a loan. Investors who buy bonds are lending a specific sum of money (the principal) to the bond issuer—a corporation, a government, or some other borrowing institution—for a specified period of time (the term).Typically, the bond issuer promises to make regular payments of interest to the investor at a rate that is set when the bond is is why bonds are often referred to as fixed income investments. | HARVARD BUSINESS SCHOOL Fractionalization and the municipal bond market Daniel Bergstresser Randolph Cohen Siddharth Shenai Working Paper 11-128 Copyright 2011 by Daniel Bergstresser Randolph Cohen and Siddharth Shenai Working papers are in draft form. This working paper is distributed for purposes of comment and discussion only. It may not be reproduced without permission of the copyright holder. Copies of working papers are available from the author. Fractionalization and the municipal bond market Daniel Bergstresser Randolph Cohen Siddharth Shenai First version April 2010. Current draft June 2011. Comments welcome. Abstract We study the impact of ethnic and religious fractionalization on the . municipal debt market and find that issuers from more ethnically and religiously fractionalized counties pay higher yields on their municipal debt. A two standard deviation increase in religious fractionalization is associated with a six basis point increase in bond yields and a two standard deviation increase in ethnic fractionalization is associated with a ten basis point increase. To provide a scale for these results a four-notch rating change from AAA to AA- is associated with an eight basis point increase in yields. Additional analysis suggests that at least some of this effect is not driven by the risk of the bonds but instead reflects inefficiency in the underwriting process. Keywords Fractionalization municipal bonds. We are grateful for support from Harvard Business School. We are also grateful for comments from Alexander Whalley Andrei Shleifer and Alberto Alesina and from seminar participants at the SEC HBS Boston College USC and UC-Merced. Finally we are grateful for excellent research assistance from Mei Zuo. Sid Shenai is at Bracebridge Capital. Daniel Bergstresser and Randolph Cohen have primary academic appointments. Both also engage in consulting and other activities in the investment management industry. Details are available upon request. .

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