Municipal Bond Basis

Patrick J. Cusatis

Municipal Finance Journal, 2006, vol. 27, issue 3, 19 - 33

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 naïve 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.

Date: 2006
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