An examination of the long-run equilibrium relationship between taxable and tax-exempt interest rates

The purpose of this research is to examine the relationship between taxable and tax-exempt interest rates. This paper examines the cause and effect relationship between taxable and tax-exempt yields and the factors that cause the tax-exempt to taxable yield ratio to change over time. The exact relationship between taxable and tax-exempt yields is still unresolved.

Prior studies have examined the tax-exempt to taxable yield ratio. However, these studies do not say anything about the cause and effect relationship between taxable and tax-exempt yields. The yield ratio may change because of changes in the tax-exempt yield, the taxable yield, or both. It is not clear if changes in the tax-exempt yield lead changes in the taxable yield, or whether the opposite is true. This paper directly examines the cause and effect relationship between taxable and tax-exempt yields.