Abstract
Underpricing of municipal bond offerings in the primary market raise borrowing costs for state and local borrowers. We argue that a significant part of the primary market underpricing can be explained as compensation to dealers for their bearing of the price risk of newly-issued bonds. We demonstrate this by showing empirically that underpricing is increasing in the volatility of the market for United States Treasury bonds, in municipal bond market spreads, in municipal bond spread volatility, and in the duration of the newly-issued bonds.