Municipal Bond Insurance Premium, Credit Rating, and Underlying Credit Risk
Article first published online: 19 MAR 2012
© 2012 Public Financial Publications, Inc.
Public Budgeting & Finance
Volume 32, Issue 1, pages 128–156, Spring 2012
How to Cite
LIU, G. (2012), Municipal Bond Insurance Premium, Credit Rating, and Underlying Credit Risk. Public Budgeting & Finance, 32: 128–156. doi: 10.1111/j.1540-5850.2011.01005.x
- Issue published online: 19 MAR 2012
- Article first published online: 19 MAR 2012
This article explores the question of whether bond insurers are able to sufficiently evaluate the credit risk of insured bonds, the answer to which would determine the future of municipal bond insurance. A sample of insured municipal bonds is investigated to determine whether bond insurance premia can predict the future credit rating transition, the proxy for bond credit risk. The results show that municipal bond insurance premia, conditional on bond credit ratings and other explanatory variables, have explanatory power over credit rating downgrades but not over upgrades. As such, bond insurance premia convey extra information about the underlying credit risk of a bond issue than the original credit rating reveals. This research also provides evidence that the rating agencies might not be doing as a good job as they could potentially do.