Polluting Public Funds: The Effect of Environmental Regulations on Municipal Bonds

We present two findings on how environmental policy uncertainty impacts municipal bond returns. First, yields increase after a new pollution standard is proposed but decrease after this standard is finalized. Second, after annual announcements of compliance status, yields fall for counties that remain in compliance but increase for newly noncompliant counties. We present suggestive evidence linking these short-run municipal bond market reactions to long-run changes in pollution and housing prices. Our findings suggest that increases in either regulatory stringency or uncertainty over future environmental policy increase the cost of municipal debt raised to fund schools, hospitals, and critical infrastructure. This paper was accepted by Tomasz Piskorski, finance. Supplemental Material: The online appendices and data files are available at https://doi.org/10.1287/mnsc.2023.02340 .