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Fractionalization and the municipal bond market
Daniel Bergstresser*
Randolph Cohen**
Siddharth Shenai***

(First version April 2010. Current draft June 2011. Comments welcome.)

Abstract
We study the impact of ethnic and religious fractionalization on the U.S. municipal debt market, and find that issuers from more ethnically and religiously fractionalized counties pay higher yields on their municipal debt. A two standard deviation increase in religious fractionalization is associated with a six basis point increase in bond yields, and a two standard deviation increase in ethnic fractionalization is associated with a ten basis point increase. To provide a scale for these results, a four-notch rating change, from AAA to AA-, is …show more content…

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Electronic copy available at: http://ssrn.com/abstract=1844685

Study, a survey of the major religious denominations conducted by the Association of
Statisticians of American Religious Bodies.2 In this context, fractionalization represents the probability that two randomly selected members of a group will share a particular attribute. For example, in a society that is half white and half Hispanic, the ethnic fractionalization measure would be 0.5; there would be a 50 percent chance that any two randomly selected people would be of the same ethnicity. Fractionalization is the most common measure used to capture the extent to which a particular society is divided across a particular characteristic.
We focus on ethnic and religious fractionalization because these characteristics are both salient and relatively fixed. Wealth, income, and education are not directly observable, and like age they vary mechanically over the life cycle. Ethnic and religious affiliations are generally more static. These measures capture the underlying concept that we focus on, namely the strength of social ties across citizens and between citizens and officials in a local area.
We find evidence that municipal issuers in religiously fractionalized counties pay more to borrow than those in other counties. The point estimates suggest

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