The Value of the Advance Refunding Option and the Refunding Efficiency of Tax-Exempt Municipal Bonds

Wei David Zhang and Jinliang Li

Municipal Finance Journal, 2004, vol. 25, issue 1, 17 - 31

Abstract: Municipal issuers have the option to advance refund an existing bond before its call date by defeasance refunding.This paper develops a simple and practical multi-period model in discrete time with stochastic discount factors to price this advance refunding option (ARO). Our analysis focuses on the link between yield curves and refunding efficiency and shows explicitly how the value of the ARO and refunding efficiency for municipal bonds can be obtained from yield curves and interest rate volatility.

Date: 2004
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