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The Journal of Fixed Income

The Journal of Fixed Income

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Primary Article

Effects of Credit Quality on Tax-Exempt and Taxable Yields

Sheen Liu, Junbo Wang and Chunchi Wu
The Journal of Fixed Income Fall 2003, 13 (2) 80-99; DOI: https://doi.org/10.3905/jfi.2003.319355
Sheen Liu
An assistant professor of finance at the Williamson College of Business of Youngstown State University in Youngstown, OH.
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  • For correspondence: sheenliu@yahoo.com
Junbo Wang
A Ph.D. candidate in finance at the School of Management at Syracuse University in Syracuse, NY.
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  • For correspondence: jwang13@syr.edu
Chunchi Wu
A professor of finance at the School of Management at Syracuse University.
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  • For correspondence: cwu@syr.edu
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Abstract

An examination of the effects of credit quality on the relative yields of Treasuries and municipals reveals that the municipal term structure model with no default risk underestimates equilibrium marginal income tax rates and yields of municipals relative to yields of Treasuries. The downward bias is more severe for long-maturity and low-rated bonds. Incorporating default risk into the municipal term structure model helps explain a considerable portion of the relative yields of tax-exempt and taxable bonds, and generates much more accurate estimates of implicit marginal income tax rates. After controlling for the effect of default, the estimated implicit tax rates for long and short bonds become quite comparable and consistent with the tax regime.

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The Journal of Fixed Income
Vol. 13, Issue 2
Fall 2003
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Effects of Credit Quality on Tax-Exempt and Taxable Yields
Sheen Liu, Junbo Wang, Chunchi Wu
The Journal of Fixed Income Sep 2003, 13 (2) 80-99; DOI: 10.3905/jfi.2003.319355

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Effects of Credit Quality on Tax-Exempt and Taxable Yields
Sheen Liu, Junbo Wang, Chunchi Wu
The Journal of Fixed Income Sep 2003, 13 (2) 80-99; DOI: 10.3905/jfi.2003.319355
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