Political polarization and state government bonds

Abstract

This study examines the effect of political polarization in state legislatures on state bond yields in the United States. Political polarization, defined as the ideological divide between Democratic and Republican members of the state legislative chambers, reflects legislators' willingness to seek bipartisan compromises. We expect high polarization states to be riskier because they are likelier to experience gridlock, negatively affecting economic development and debt service commitment. Findings suggest a significant positive relation between bond yields and political polarization. A one-standard-deviation increase in polarization increases bond yields by 7.81 basis points and total interest expense by $2.3 million for an average bond issue. Additionally, this study finds that the effect of polarization on bond yields is stronger for general obligation bonds.