Why is there any point to munis?
By that I mean, why aren't yields driven down to be equal to the after-tax yields of taxable bonds of similar maturities and credit quality?
Obviously they are driven down somewhat, but why aren't they driven down to the point of indifference?
The "market" thinks that there is a greater risk than the S&P/Moody ratings imply.
A study I did about 6 years ago showed a wider variataion between YTM for corporate bonds with the same ratings and maturity than I might have thought.
That would only be expected if both muni & corporate bond yields were set by the demand from taxable individual investors in the US. US individuals are most of the market for munis, and very little of the market for corporates.
-Tad
Given the near-infinite range of tax situations that people can find themselves in (or predict themselves to be in), and the similar range of opinions on what the true credit quality might be, how could we ever know that the indifference point has or has not been reached?
Cheers,
Xho
I have little to add to the other explanations of why the yield of municipal bonds exceeds the after-tax yield of corporate bonds for most investors. One implication of this fact is that it may be optimal to have muni bonds in your taxable account and stocks in your tax-deferred account, rather than stocks in your taxable account and corporate bonds in the tax-deferred account, as is sometimes suggested. You need to make some assumptions about future returns to solve the "asset location" problem. I wonder if there are online calculators that do so.
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