Municipal Credit Default Swaps : Implications for Issuers

Credit default swaps (CDS) are a widely-used risk management tool in financial markets. One of their principal, if indirect, benefits is that the market price of default protection is a real-time signal of issuer credit risk. Prior research on corporate CDS suggests that signal facilitates price discovery and in turn benefits issuers and investors. At the moment it is unclear if they convey similar benefits to the municipal bond market. I address this by examining the determinants of the price of municipal credit default protection, and whether that price affects borrowing costs on new bond issues. I find that price conveys information about management policies and practices that is not typically reflected in credit ratings. I also find that, contrary to expectations, an increase in the price of default protection decreases borrowing costs on new bond issues. I posit that finding follows from the more complete picture of idiosyncratic issuer credit risk that CDS provide