Search Frictions and Product Design in the Municipal Bond Market

Giulia Brancaccio and Karam Kang

No 30775, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper shows that product design shapes search frictions and that intermediaries leverage this channel to increase their rents in the context of the U.S. municipal bond market. The majority of bonds are designed via negotiations between a local government and its underwriter. They are then traded in a decentralized market, where the underwriter often also acts as an intermediary. Exploiting variations in state regulations that limit government officials’ conflicts of interest, we provide evidence that bond design from the government’s perspective involves a trade-off between flexibility and liquidity, but the underwriter benefits from designing and trading complex bonds. Motivated by these findings, we build and estimate a model of bond origination and trades to quantify market inefficiency driven by underwriters’ role in intermediating trades and discuss policy implications.

JEL-codes: L0 L12 L15 P0 (search for similar items in EconPapers)
Date: 2022-12
New Economics Papers: this item is included in nep-fmk, nep-ind and nep-ure
Note: IO PE POL
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Citations: View citations in EconPapers (4)

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