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The risk premia in municipal bond yields: An application of the ARCH-M model

By Roy D. Adams and Masoud Moghaddam

Abstract

This note presents empirical evidence indicating that the time-varying risk premia in municipal bond yields can in part be explained by the ARCH-M procedure. The ARCH-M model was recently developed by Engle, Lilien, and Robins to analyze the risk premia in the term structure of interest rates. We have found that for 10- and 20-year municipal bonds of three different risk classes, the risk premia have been significantly affected by recent past squared "surprises" in the excess holding yield. The pattern appears in data over the sample period 1952:i-1985:vi.

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