Municipal Debt and the Equity Cross-Section of States

This paper develops a cross-sectional neural network for municipal bond yields, filling a need to extrapolate yields on these illiquid assets. Using this neural network, counterfactual municipal bond yields are generated for all states such that the only difference in the bond issues is the year and state where the issue took place. Hypothesizing that states with higher municipal bond yields present firms with riskier business environments, I demonstrate a mean-variance investor would be indifferent between a strategy of going long firms incorporated in high yield states and holding the S&P 500 index, but that absolute returns to this strategy dwarf buy-and-hold returns by more than 67%