Why are municipal bonds issued at a premium?
Coauthor(s): Mattia Landoni
The tax treatment of capital gains and losses on tax-exempt bonds makes it profitable to avoid gains and to realize losses. However, the option to realize losses has a positive value only if the bond is issued at a premium. If tax options are the reason why municipal bonds are issued at a premium, then a novel prediction follows: the premium should be larger for bonds with longer maturity (or time to first call, if callable), in order to accommodate the greater price volatility. I show that this “term structure of issue prices” exists, using a collection of 200,000 unique securities held by insurance companies. Thus, even in an opaque market such as the municipal bond market, issuers issue securities that maximize investors' value.
Mattia Landoni "Why are municipal bonds issued at a premium?." , Columbia Business School, (2013).