Political Uncertainty and Public Financing Costs: Evidence from U.S. Gubernatorial Elections and Municipal Bond Markets

Abstract

We investigate how political uncertainty around U.S. gubernatorial elections affects local government borrowing costs. Municipal bond yields sharply increase by 7 basis points before an election and reverse afterward. This political risk premium is higher during economic downturns and close elections, especially when voters are more risk averse, and lower for states with balanced budget restrictions or financial disclosure requirements. Insurance mitigates the political uncertainty effect, but only pre-2008 when insurers were solvent. Pre-election institutional trading demand also significantly decreases. Overall, our evidence indicates that government debt is more costly and difficult to issue when political uncertainty is high.

Keywords: Political Uncertainty, Elections, Public Financing Costs, Municipal Bonds

JEL Classification: G12, G18, G28