Fiscal news, state budget rules, and tax-exempt bond yields

This paper investigates how state fiscal institutions such as balanced-budg et rules and restrictions on state debt issuance mediate the bond market re action to state fiscal news. We analyze data on the yields of bonds issued by different states, as reported in the "Chubb Relative Value Survey," alon g with data on state budget forecasts for the period 1988-1998. We find tha t unexpected deficits are correlated with higher state bond yields. This ef fect is smaller for states with tight antideficit rules than for states wit hout these fiscal rules. Unexpected deficits have a particularly large effe ct in raising bond yields of states with tax limits. These results suggest that bond market participants view fiscal institutions as relevant in asses sing the risk characteristics of tax-exempt bonds and that the economic sig nificance of these institutions depends on the state's economic and fiscal circumstances. (C) 2001 Academic Press.