Informed Investors and Underpricing in Municipal Bond Offerings

This paper studies the effect of local mutual funds on municipal bond issuance. Offering yield spreads are higher in states where municipal bond funds' headquarters are located, and in states with larger aggregate fund size. However, holding local fund size constant, yield spreads decrease in the number of local funds. There is evidence for local funds' informational advantage: for a given fund, its local holdings are more likely to be upgraded (less likely to be downgraded) than its non-local holdings. A model of security underpricing that incorporates multiple imperfectly informed investors confirms my empirical findings.