The Right and Wrong Models for Evaluating Callable Municipal Bonds

Direct Versus Indirect Federal Bond Subsidies: New Evidence on Cost of Capital

“…However, our analysis shows that the interest cost benefits for the counterfactual tax‐exempt bonds—assuming the availability of an advance refunding—was existent but relatively small (i.e., 1.8 basis points) compared to issuers waiting to refund their bonds on a current refunding basis. This provides additional support to the importance of systematically valuing the call option and, specifically, to the notion that state and local governments are not necessarily worse off waiting until the call date to refinance their debt (Boyce and Kalotay 1979; Kalotay and May 1998; Orr and de la Nuez 2013; Orr and de la Nuez 2014; Orr and Martin, 2019; Zhang and Li 2004). Of course, these results are only representative of 43 counterfactual bond issues, so we need to be careful offering strong policy implications based on this finding.…”