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Determinants of Underwriters' Spreads on Tax Exempt Bond Issues**

Published online by Cambridge University Press:  19 October 2009

Richard R. West
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Extract

This paper examines the determinants of underwriters' spreads on tax exempt bond issues. In particular, it investigates the effect on spreads of differences in issue quality, term to maturity, and size. In addition, changing money market conditions and variations in the degree of competition among underwriters of tax exempts are analyzed for their influence on spread behavior. The relationships are studied for virtually all state bond issues sold between July 1, 1959 and December 31, 1965. The principal method of investigation is multiple regression analysis.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 2 , Issue 3 , September 1967 , pp. 241 - 263
Copyright
Copyright © School of Business Administration, University of Washington 1967

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References

1 See Robinson, Roland I., The Postwar Market for State and Local Government Securities, National Bureau of Economic Research, “Studies in Capital Formation,” No. 5 (Princeton, N. J.: Princeton University Press), pp. 117–119Google Scholar; and IBA Statistical Bulletin, Occasional Paper No. 7, June, 1964.

2 See, for example, Fundamentals of Municipal Bonds, Investment Bankers Association, Washington, 1961, pp. 9–10Google Scholar; Bogen, Jules I. (Editor), Financial Handbook, 4th Edition (New York, N. Y.: Ronald Press, 1964), Sec. 9, pp. 18–19Google Scholar; Haven, Thomas K., Investment Banking Under the Securities and Exchange Commission (Ann Arbor, Mich.: University of Michigan Press, 1940)Google Scholar; Waterman, Merwin H., Investment Banking Functions (Ann Arbor, Mich.: University of Michigan Press, 1958)Google Scholar.

3 In addition to Robinson, op. cit., and IBA, op. cit., see Cohan, Avery B., Cost of Flotation of Long Term Corporate Debt Since 1935 (Chapel Hill, N. C. : University of North Carolina Press, 1961)Google Scholar, and Friend, Irwin, Investment Banking and the New Issues Market: Summary Volume (Philadelphia, Pa., University of Pennsylvania Press, 1965), Chapter 7, pp. 67–77Google Scholar.

4 Conard, Joseph W., The Behavior of Interest Rates (New York: National Bureau of Economic Research, 1966), p. 114.Google Scholar

5 Scott, Ira O. Jr., Government Securities Market (New York: McGraw-Hill Book Company, 1965), pp. 143–159Google Scholar.

6 See, for example, Fama, Eugene, “The Behavior of Stock Market Prices,” Journal of Business, Vol. XXXVIII, No. 1, January, 1965Google Scholar.

7 See Conard, op. cit., and Scott, op. cit.

8 Scott, Op. cit., pp. 21–22.

9 Conard, op. cit., p. 115.

10 See, for example, Cohan, op. cit.; Heins, A. James, “The Interest Rate Differential Between Revenue Bonds and General Obligations: A Regression Model,” National Tax Journal, December, 1962, pp. 399–405Google Scholar; or De Monte Phelps, Charlotte, “The Impact of Monetary Policy on State and Local Government Expenditures in the United States,” in Suits, D. B., et al. , Impacts of Money and Credit (Englewood Cliffs, N. J.: Prentice-Hall), 1963Google Scholar.

11 See West, Richard R., “A Weekly New Issue Yield Curve for Municipal Bonds: A Comment,” National Banking Review, December 1964, pp. 257–262Google Scholar.

12 The correlation coefficients between spreads and the 1, 2, 3, and 4-week yield differences were as follows: .087, .102, .112, and .094. Because this procedure was criticized by several of my colleagues on the grounds that week to week changes may be very erratic, I also constructed a fitted yield trend variable. Each weekly observation was the ratio of the trend in yields over the previous 4 weeks divided by the average yield over the same period. Unfortunately, this variable was not as highly correlated with spreads (.078) as the 3-weeks offering interval.

13 See, for example, Dewald, William, “Free Reserves, Total Reserves, and Monetary Control,” Journal of Political Economy, April, 1963, pp. 141–154Google Scholar.

14 See West, Richard R., “New Issue Concessions on Municipal Bonds: A Case of Monopsony Pricing,” Journal of Business, April, 1965, pp. 135–149Google Scholar.

15 Ibid.

16 During 1960 and 1961, for example, several large issues of the State of California sold out very quickly, thus biasing upward the Bond Buyer's figures for the percentage of the previous week's volume of tax exempts sold.

17 Robinson, op. cit., p. 117.

18 On this point see West, Richard R., “New Issue Concession on Municipal Bonds: A Case of Monopsony Pricing,” Journal of Business, April, 1965, pp. 135–148Google Scholar.

19 was set equal to zero to prevent perfect correlation among .

20 For a more thorough analysis of the “Morris Episode,” see West, Richard R., “Bidding Competition for Municipal Bonds,” Financial Analysts Journal, July–August, 1965Google Scholar.

21 Business Week, October 7, 1961, p. 105.

22 According to Lawrence Fisher, who developed this test, the statisticy “has approximately the X2 distribution with T-1 degrees of freedom. Hence an improbable high value of y is cause for rejecting the hypothesis that the partial regression coefficients are estimates from the same population.” See Fisher, Lawrence, “Determinants of Risk Premiums on Corporate Bonds,” Journal of Political Economy, June, 1959, p. 29Google Scholar.

23 Robinson, op. cit.

24 IBA Statistical Bulletin, op. cit.

25 Robinson, op. cit., p. 116.

26 Ibid., p. 117.

27 Robinson, op. cit., p. 117.

28 IBA, op. cit., p. 5.

29 At present I am investigating the behavior of spreads on tax exempts during the particularly difficult period of July to September of 1966. Certainly, if spreads are influenced by market conditions, it should be apparent in these data.

30 See Investment Banking and the New Issue's Market-Summary Volume, Chapter VII, pp. 67–77, Wharton School of Finance and Commerce (Philadelphia, pa.: University of Pennsylvania Press, 1965)Google Scholar.