Investor attention and municipal bond returns

We analyze whether investors in opaque markets price information from more transparent markets. Exploiting the natural experiment created by bond-insurer insolvency, we show that U.S. municipal bond investors did not price early signs of insurers' increased default risk revealed through the equity and CDS markets, and only reacted when these insurers were later downgraded. Institutional investors respond to information faster than retail investors, but still with significant delay. The severity of the investor inattention we document is relevant to the current debate over the costs and benefits of SEC proposals to improve the timeliness and quality of local government disclosure.