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Municipal Bond Pricing: A Data Driven Method

Natraj Raman () and Jochen L. Leidner ()
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Natraj Raman: Thomson Reuters, 30, South Colonnade, London E14 5EP, UK
Jochen L. Leidner: Thomson Reuters, 30, South Colonnade, London E14 5EP, UK

International Journal of Financial Studies, 2018, vol. 6, issue 3, 1-19

Abstract: Price evaluations of municipal bonds have traditionally been performed by human experts based on their market knowledge and trading experience. Automated evaluation is an attractive alternative providing the advantage of an objective estimation that is transparent, consistent, and scalable. In this paper, we present a statistical model to automatically estimate U.S municipal bond yields based on trade transactions and study the agreement between human evaluations and machine generated estimates. The model uses piecewise polynomials constructed using basis functions. This provides immense flexibility in capturing the wide dispersion of yields. A novel transfer learning based approach that exploits the latent hierarchical relationship of the bonds is applied to enable robust yield estimation even in the absence of adequate trade data. The Bayesian nature of our model offers a principled framework to account for uncertainty in the estimates. Our inference procedure scales well even for large data sets. We demonstrate the empirical effectiveness of our model by assessing over 100,000 active bonds and find that our estimates are in line with hand priced evaluations for a large number of bonds.

Keywords: municipal bonds; yield curves; nonparametric Bayesian; hierarchical model; sparse data (search for similar items in EconPapers)
JEL-codes: G1 G2 G3 F2 F3 F41 F42 (search for similar items in EconPapers)
Date: 2018
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