Bond Insurance: What Is Special About Munis?
Article first published online: 27 NOV 2005
The Journal of Finance
Volume 59, Issue 5, pages 2253–2280, October 2004
How to Cite
NANDA, V. and SINGH, R. (2004), Bond Insurance: What Is Special About Munis?. The Journal of Finance, 59: 2253–2280. doi: 10.1111/j.1540-6261.2004.00698.x
- Issue published online: 27 NOV 2005
- Article first published online: 27 NOV 2005
Close to 50% of municipal bonds are prepackaged with insurance at the time of issue. We offer a tax-based rationale for the emergence of third-party insurance of tax-exempt bonds. We argue that insurance adds value as it allows a third party to become, in a probabilistic sense, an issuer of tax-exempt securities. Insurance however reduces value by eliminating the possibility of a capital tax loss. While the net benefit from insurance increases with bond maturity, the benefit may not increase monotonically with default risk. We also provide empirical evidence supportive of the model's predictions.