Municipal Bond Basis
Author: Patrick J. Cusatis.
Source: Volume 27, Number 03, Fall 2006 , pp.19-33(15)
< previous article |next article > |return to table of contents
Abstract:
The ratio of municipal bond yields to taxable yields is commonly called “basis.” In examining cross-market hedging in the municipal bond market, this paper finds that basis changes are inversely related to changes in the level of interest rates and that changes in basis cause extreme volatility in a hedged municipal bond portfolio. Ratios are found to be much lower than those predicted by a naive hedging strategy and are shown to be dynamic. The paper presents a closed-end solution for cross-market hedge ratios given an expected change in basis.Keywords:
Affiliations:
1: Pennsylvania State University.