Thesis Title:
Political Polarization and Its Impact on Local Economies
Thesis Abstract:
Political partisanship increasingly shapes economic expectations and investor behavior, yet its effects on U.S. municipal finance remain underexplored. This paper investigates whether political (mis)alignment between state governors and the sitting president influences municipal bond markets. Municipal bonds finance the bulk of local infrastructure and public services, making borrowing costs a critical measure of local governments’ fiscal capacity. I define political misalignment as a mismatch in party affiliation between a state governor and the president, and study its causal effect on municipal bond yields. To address endogeneity concerns, I exploit close gubernatorial elections—decided by a margin of five percentage points or less—as a quasi-experimental setting that renders misalignment plausibly random.
I find that political misalignment raises municipal bond yields by 7.8 to 9.4 basis points in the two years following an election, an increase equivalent to about 5% of the average issuance yield in my sample (2005–2019). This effect is economically meaningful, amounting to roughly half the yield reduction from a credit rating upgrade. Exploring mechanisms, I show limited evidence that shifts in partisan investor sentiment explain the results. Instead, the primary channel is fiscal: misaligned states experience a 30% decline in per capita federal transfers, weakening local budgets and elevating perceived risk. These findings highlight how national political dynamics directly shape local borrowing costs, linking partisanship to financial markets and to the fiscal capacity of U.S. local governments.
Primary Supervisor:
Dr Marcin Kacperczyk