School District Bond Advance Refunding and Option Value Loss

Komla Dzigbede

Municipal Finance Journal, 2017, vol. 38, issue 2, 39 - 57

Abstract: Advance bond refunding presents immense benefits, including interest cost savings, to public managers and their constituents. Although the subject of interest cost savings from advance refunding often engages public attention, not much is known about the opportunity costs, or option value loss, associated with the timing of refunding operations. This article analyzes the timing of advance bond refunding operations and the resulting option value loss. It uses Monte Carlo simulation and financial option pricing techniques to measure option value loss and assesses how option value loss evolved across different epochs before, during, and immediately following the Great Recession. Data are from a random sample of Texas school district advance bond refunds and cover 2005 to 2014. Results show that option value loss was, on average, $3.28 per $100 of par value and was more severe during the Great Recession. The findings highlight option value loss as an additional factor to consider in assessments of debt management efficiency, which tend to focus extensively on interest cost savings.

Date: 2017
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