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Stock Market Yields and the Pricing of Municipal Bonds

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  • N. Gregory Mankiw
  • James M. Poterba
Abstract
This paper proposes an alternative to the traditional model for explaining the spread between taxable and tax-exempt bond yields. This alternative model is a special case of a general class of clientele models of portfolio choice and asset market equilibrium. In particular, we consider a setting with two types of investors, a taxable investor and a tax-exempt investor, who hold specialized bond portfolios. The tax-exempt investor holds only taxable bonds, and the taxable investor holds only tax-exempt bonds. Both investors hold equity, and the taxable and tax-exempt bond markets are linked through the equilibrium conditions governing equity holding and bond holding for each type of investor. In contrast to the traditional model, this alternative model has the potential to explain the small observed spread between taxable and tax-exempt yields. In addition, this model predicts that the yield spread between taxable and tax-exempt bonds should be an increasing function of the dividend yield on corporate stocks. Although the substantial changes in the tax code during the last four decades complicate the testing of this model, we find some support for the predicted relationship between the equity dividend yield and the yield spread between taxable and tax-exempt bonds.

Suggested Citation

  • N. Gregory Mankiw & James M. Poterba, 1996. "Stock Market Yields and the Pricing of Municipal Bonds," NBER Working Papers 5607, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:5607
    Note: AP EFG ME PE
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    References listed on IDEAS

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    1. Trzcinka, Charles A, 1982. "The Pricing of Tax-Exempt Bonds and the Miller Hypothesis," Journal of Finance, American Finance Association, vol. 37(4), pages 907-923, September.
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    Cited by:

    1. Sang-Yeob Lee & SungMan Yoon, 2019. "Relationship between Financial Income Tax Reform and Implicit Tax: Case of South Korean Bond Market," Asian Economic and Financial Review, Asian Economic and Social Society, vol. 9(8), pages 964-976, August.
    2. Coronado, Julia Lynn, 1999. "Tax Exemption and State Capital Investment," National Tax Journal, National Tax Association, vol. 52(n. 3), pages 473-82, September.
    3. Shoven, John B. & Sialm, Clemens, 2004. "Asset location in tax-deferred and conventional savings accounts," Journal of Public Economics, Elsevier, vol. 88(1-2), pages 23-38, January.
    4. Slemrod, Joel & Greimel, Timothy, 1999. "Did Steve Forbes scare the US municipal bond market?," Journal of Public Economics, Elsevier, vol. 74(1), pages 81-96, October.
    5. Pischke, Jorn-Steffen & Dinardo, John & Hallock, Kevin F, 2000. "Unions And The Labour Market For Managers," CEPR Discussion Papers 2418, C.E.P.R. Discussion Papers.
    6. Graham, John R., 1999. "Do personal taxes affect corporate financing decisions?," Journal of Public Economics, Elsevier, vol. 73(2), pages 147-185, August.
    7. Lorenz Kueng, 2014. "Tax News: The Response of Household Spending to Changes in Expected Taxes," NBER Working Papers 20437, National Bureau of Economic Research, Inc.
    8. John B. Shoven & David A. Wise, 1998. "The Taxation of Pensions: A Shelter Can Become a Trap," NBER Chapters, in: Frontiers in the Economics of Aging, pages 173-212, National Bureau of Economic Research, Inc.
    9. John B. Shoven, 1999. "The Location and Allocation of Assets in Pension and Conventional Savings Accounts," NBER Working Papers 7007, National Bureau of Economic Research, Inc.

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