Role of friendship networks (social connectedness) in the municipal bond market

Using a novel dataset from Facebook, I examine how the social connectedness and word-of-mouth communications affect municipal bond market outcomes. I conjecture that higher social connectedness between counties within a state and higher social connectedness within a county lead to lower municipal bond yields. Specifically, I hypothesize that the risk of municipal bonds is expected to be moderated by the social connectedness because of two plausible reasons. Firstly, social connectedness may function as a mechanism that eliminates information asymmetry between investors and issuers by providing information of municipal bond issuers. Secondly, social connectedness may function as a mechanism that imposes a greater cost and harsher punishment for opportunistic and unethical behavior. I empirically assess the validity of these arguments in this study. My findings confirm that bond yields are lower for municipalities and local governments when social connectedness between counties within a state and higher social connectedness within a county are higher. I also show that the effect of social connectedness on municipal bond yields is driven by within-state social connectedness. This paper provides empirical evidence in support of the argument that the risk associated with municipal bonds is lower when local governments and other municipal bond issuers are located in counties or regions with high social connectedness.