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Market-Based Solutions to Vital Economic Issues
Research
Dec 22, 2019

The Term Structure of Municipal Bond Yields, Local Economic Conditions, and Local Stock Returns

Abstract

This study shows that the municipal yield curve is informative about local economic outcomes. Controlling for Treasury yields, a flatter municipal yield curve not only predicts deteriorating local economic conditions, such as higher unemployment rates and more macroeconomic uncertainty, but also signals greater risk for locally headquartered firms. An investment strategy that exploits this fact by buying (selling) the firms located in states where municipal yield curve is relatively flat (steep) earns an excess return that exceeds 5% per annum. These novel empirical results indicate that the municipal debt market provides valuable information about the trajectories and risks of local economies.

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