| This study estimated the effects of tax-exempt industrial-aid bond financing on the overall level of tax-exempt bond yields. An underlying premise of the study was that the tax-exempt bond market is segmented from other bond markets. The validity of this hypothesis was empirically verified.;In the model developed, the demand for tax-exempt bonds was represented by a system of three demand equations: demand by households, demand by commercial banks, and demand by property insurance companies. The supply of new tax-exempts in the model was taken to be the sum of new short-term bond issues, new long-term issues, and new industrial-aid issues. This model was empirically tested by evaluating the statistical correlation between the tax-exempt yield and the difference between the above measures of supply and demand. Support for the theory required that a positive value of the difference (excess supply) result in increased yields and that a negative value of the difference (excess demand) result in decreased yields. Such a significant, positive correlation was found for quarterly data from 1965 through 1978 and for annual data from 1947 through 1978.;The study establishes quite firmly that because industrial-aid bonds represent an overall increase in the supply of tax-exempt bonds, their use will increase the difference between supply and demand and, therefore, will result in an increase in tax-exempt bond yields. The historical magnitude of this increase was estimated and presented on a quarterly basis from 1971 through 1978. It appears that for every one billion dollar increase in additional tax-exempt bonding, the interest rate can be expected to rise by about 31 basis points.;Three major conclusions can be drawn from the research undertaken. First, the tax-exempt bond yield is a function of the difference between new supply and purchases made by households, banks, and insurance companies. Second, the use of industrial-aid bonds will result in a predictable increase in tax-exempt yields. Third, these results provide strong empirical support for the theory of market segmentation.;Estimating the tax-exempt yield impacts of industrial-aid bond financing necessitated the use of an accurate model of tax-exempt yield determination. Earlier studies analyzed models that were based on the theory that households were residual rather than primary bond purchasers. In this study the validity of these models for the 1960s and early 1970s was confirmed. However, these models were not found to be valid for the period 1971-78, nor for the full estimation period 1965-78. This study then developed and tested an alternative model. |
