The Municipal Bond Market in Italy: an empirical analysis of the determinants of yields and credit ratings

This PhD thesis investigates the sub-sovereign financial market in Italy, specifically focusing on the municipal bond market and on local government credit ratings. This research aims to identify empirically the economic and financial variables which affect bond yields and credit ratings of Italian local governments, and to understand the role of such variables in explaining the differences in interest costs paid by different bond issuers (or paid by the same issuer at different times) and the differences in the rating judgments assigned by the major international rating agencies. The Italian local government finance system is characterized by the several tiers of sub-sovereign governments (regions, provinces and cities) being differently linked to the central government finances, and by the central government itself conveying a non-negligible sovereign financial risk. The three local government tiers have a different institutional nature, while cities and provinces (jointly defined as local authorities) possess a similar status and are subject to the same legislation, regions are characterized by a greater independence and by a significantly higher degree of financial autonomy. These facts should affect the investors’ evaluation of local government credit risk and, therefore, one of the aims of this research is to analyze the determinants of subsovereign bond yields and credit ratings in this institutional framework. Credit ratings are investigated under a dual perspective, beyond the analysis on the factors driving the determination of credit ratings, this research also aims to study the role played by ratings in affecting local bond yields. First, testing if the purchase of a rating is rewarded by lower yields, i.e. if rated issuers pay lower yields than their unrated peers, and then if the specific creditworthiness assessment assigned by rating agencies is considered by investors when they price a municipal bond, i.e. if a AAA-rated issuer pays less than a BBB-rated one. This work is organized in two parts. Part I provides the research framework, rationale and background, including the research planning, a description of the local government finance system in Italy and the review of the literature. Part II is dedicated to the empirical analysis, presenting the empirical methodology and results.