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A special political connection, i.e., the implicit guarantee of the government on the debts of borrowers, is considered in this article to explore the mechanism through which the implicit guarantee of government will affect the interest rate of bonds issued by borrowers. Theoretical analysis shows that if the implicit guarantee from the government is less convincing, only investment income will play an important role in the determination of interest rate while explicit credence will not affect interest rate. If the implicit guarantee is persuasive, both explicit credence and investment income will affect the interest rate of bonds. Empirical analysis of Chinese urban investment bonds and U.S. municipal bonds during 2006–11 supports our theoretical predictions.
