The Market(s) Left Behind : Price Formation in Municipal Secondary Trades

This study addresses the determinants of municipal secondary trade prices for state general obligation bonds issued during 2005-2010. I find that a two-component finite mixture model, as postulated in the hypothesis of price dispersion under market opacity, remains the best specification for the municipal secondary market. There are distinct pricing regimes that persist even after controlling for the effects of illiquidity, market segmentation, fixed costs, and market fundamentals. Consistent with the theory of information economics, some municipal transactions (predominantly smaller household trades) are facing inferior prices in the municipal OTC market. Moreover, trades in the more informed price regime appear to be facing prices that became even more favorable during and after the Great Recession, while trades in the less informed price regime appear to be worse-off during the same period