Abstract
We establish necessary and sufficient conditions for a linear taxation system to be neutral—within the multi-period discrete time “no arbitrage” model—in the sense that valuation is invariant to the exact sequence of tax rates, realization dates as well as immune to timing options attempting to twist the time profile of taxable income through wash sale transactions.
“In the study of investments, taxes are largely a source of embarrassment to financial economists.”
(Introduction to Dybvig and Ross 1986)
“Accordingly, my approach in this chapter is to examine the restrictions on the income measurement rules applicable to financial instruments implied by the requirement that the rules be linear. . . . Linearity is a desideratum of a tidy tax system.”
(Bradford 2000, p. 373–374)
This is a preview of subscription content, log in via an institution to check access.
Similar content being viewed by others
References
Auerbach, A.J.: Retrospective capital gains taxation. Am Econ Rev 81(1), 167–178 (1991)
Auerbach, A.J., Bradford, D.: Generalized cash-flow taxation. J Public Econ 88, 957–980 (2004)
Basak, S., Croituro, B.: Non-linear taxation, tax-arbitrage and equilibrium asset prices. J Math Econ 35, 347–382 (2001)
Basak, S., Gallmeyer, M.: Capital market equilibrium with differential taxation. Eur Finance Rev 7, 121–159 (2003)
Bradford, D.F.: Taxation, Wealth and Saving. MIT Press, Cambridge (2000)
Brown, E.C.: Business income, taxation, and investment incentives. In: Metzler et al. (1948)
Cadenillas, A., Pliska, S.R.: Optimal trading of a security when there are taxes and transactions costs. Financ Stoch 3, 137–165 (1999)
Chen, A.: Research in Finance. JAI Press, Greenwich (1987)
Constantinides, G.M.: Capital market equilibrium with personal taxes. Econometrica 51, 611–636 (1983)
Constantinides, G.M.: Optimal stock trading with personal taxes: Implications for prices and the abnormal january return. J Financ Econ 13, 65–89 (1984)
Constantinides, G.M., Ingersoll, J.: Optimal bond trading with personal taxes. J Financ Econ 13, 299–335 (1984)
Cox, J.C., Rubinstein, M.: Options Markets. Prentice-Hall, Englewood Cliffs (1985)
Dammon, R.M.: A security market and capital structure equilibrium under uncertainty with progressive personal taxes. In: Chena (1987), pp. 53–74 (1987)
Dammon, R.M., Green, R.C.: Tax arbitrage and the existence of equilibrium prices for financial assets. J Financ 42, 1143–1166 (1987)
Dammon, R.M., Spatt, C.S.: The optimal trading and pricing of asymmetric capital gains taxes and transaction costs. Rev Financ Stud 9, 921–952 (1996)
Dermody, J.C., Prisman, E.Z.: Term structure multiplicity and clientele in markets with transactions costs and taxes. J Financ 41, 893–911 (1988)
Dermody, J.C., Rockafeller, R.T.: Cash stream valuation in the face of transactions costs and taxes. math Financ 1(1), 31–54 (1991)
Dermody, J.C., Rockafeller, R.T.: Tax basis and nonlinearity in cash stream valuation. Math Finance 5(2), 97–119 (1995)
Dybvig, P., Ross, S.: Tax clienteles and asset pricing. J Financ 41, 751–763 (1986)
Jensen, B.A., Nielsen, J.A.: Pricing by ‘no arbitrage’. In: Cox, D., Hinkley, D., Barndorff-Nielsen, O. (eds.) Time Series Models: In Econometrics, Finance and Other Fields. Monographs on Statistics and Applied Probability, vol. 65, Chap. 5, pp. 177–225. London: Chapman and Hall (1996)
Kabanov, Y.M., Kramkov, D.O.: No-arbitrage and equivalent martingale measures: An elementary proof of the Harrison-Pliska theorem. Theory Probab Appl 39, 523–527 (1995)
Metzler, L.A. et al. (eds.): Income, Employment and Policy: Essays in Honor of A.H. Hansen. W.W. Norton, New York (1948)
Pliska, S.R.: Introduction to Mathematical Finance. Malden, Basil Blackwell (1997)
Ross, S.A.: Arbitrage and martingales with taxation. J Polit Econ 95, 371–393 (1987)
Schaefer, S.M.: Measuring a tax-specific term structure of interest rates in the market for British government securities. Econ J 91, 415–438 (1981)
Schaefer, S.M.: Tax-induced clientel effects in the market for British government securities. J Financ Econ 10, 121–159 (1982a)
Schaefer, S.M.: Taxes and security market equilibrium. In: Sharpe, W.F., Cootner, C.M. (eds) Financial Economics—Essays in Honor of Paul Cootner, Prentice-Hall, Englewood Cliffs (1982b)
Vickrey, W.: Averaging income for income tax purposes. J Polit Econ 47, 379–397 (1939)
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Jensen, B.A. Valuation before and after tax in the discrete time, finite state no arbitrage model. Ann Finance 5, 91–123 (2009). https://doi.org/10.1007/s10436-007-0091-1
Received:
Accepted:
Published:
Issue Date:
DOI: https://doi.org/10.1007/s10436-007-0091-1