Hostname: page-component-586b7cd67f-gb8f7 Total loading time: 0 Render date: 2024-11-28T18:03:51.023Z Has data issue: false hasContentIssue false
  • English
  • Français

An Equilibrium Model of Asset Pricing with Progressive Personal Taxes

Published online by Cambridge University Press:  06 April 2009

Tsong-Yue Lai
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper examines how the progressive personal tax rate affects the equilibrium asset pricing model. In a continuous-time framework with progressive taxation, it can be shown that the expected excess rate of return on a risky asset is an increasing function of (i) the covariance of asset return with aggregate consumption rate changes, and (ii) the covariance of asset return with the aggregation of individual wealth change, weighted by the investor's tax scheme progressivity index. The capital asset pricing model derived in the absence of tax is shown to understate the expected excess rate of return and to have a misspecification error under the progressive tax scheme. Furthermore, the expected excess rate of return can be decomposed as the consumption risk premium and tax premium. The tax premium depends on the tax structure prevailing in the economy.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 24 , Issue 1 , March 1989 , pp. 117 - 127
Copyright
Copyright © School of Business Administration, University of Washington 1989

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Arnold, L.Stochastic Differential Equations: Theory and Application. New York, NY: Wiley (1974).Google Scholar
Atkinson, A. B., and Stiglitz, J. E.. Lectures on Public Economics. New York, NY: McGraw-Hill (1980).Google Scholar
Barro, R., and Sahasakul, C.. “Measuring the Average Marginal Tax Rate from the Individual Income Tax.” Journal of Business, 56 (10 1983), 419–452.Google Scholar
Barro, R., and Sahasakul, C. “Average Marginal Tax Rates from Social Security and the Individual Income Tax.” Journal of Business, 59 (10 1986), 555–566.Google Scholar
Breeden, D. “An Intertemporal Asset Pricing Model with Stochastic Consumption and Investment Opportunities.” Journal of Financial Economics, 7 (09 1979), 265–296.Google Scholar
Breeden, D. “Consumption, Production, Inflation and Interest Rates: A Synthesis.” Journal of Financial Economics, 16 (05 1986), 3–39.CrossRefGoogle Scholar
Brennan, M. “Taxes, Market Valuation and Corporate Financial Policy.” National Tax Journal, 23 (12 1970), 417–427.Google Scholar
Constantinides, M. “Capital Market Equilibrium with Personal Tax.” Econometrica, 51 (05 1983), 611–636.CrossRefGoogle Scholar
Cox, J.; Ingersoll, J.; and Ross, S.. “An Intertemporal General Equilibrium Model of Asset Prices.” Econometrica, 53 (03 1985), 363–384.CrossRefGoogle Scholar
Dybvig, P. “An Explicit Bound on Individual Assets Deviations from APT Pricing in a Finite Economy.” Journal of Financial Economics, 12 (12 1983), 483–496.CrossRefGoogle Scholar
Kushner, H. J.Stochastic Stability and Control. New York, NY: Academic Press (1967).Google Scholar
Lai, T. Y. “Taxation, Optimal Realization Policy and Capital Asset Pricing Theory.” Unpubl. Ph.D. diss., Yale Univ. (1983).Google Scholar
Lippman, S. A., and McCall, J. J.. “Progressive Taxation in Sequential Decision Making.” Journal of Public Economics, 16 (08 1981), 35–52.Google Scholar
Litzenberger, R., and Ramaswamy, K.. “Dividend, Short Selling Restrictions, Tax-Induced Investor Clienteles, and Market Equilibrium.” Journal of Finance, 35 (05 1980), 469–481.Google Scholar
Merton, R. C. “Optimal Consumption and Portfolio Rules in a Continuous-time Model.” Journal of Economic Theory, 3 (12 1971), 373–413.Google Scholar
Merton, R. C. “An Intertemporal Capital Asset Pricing Model.” Econometrica, 41 (09 1973), 867–887.Google Scholar
Roll, R. “A Critique of the Asset Pricing Theory's Tests.” Journal of Financial Economics, 4 (03 1977), 129–176.Google Scholar
Ross, S. A. “Debt and Taxes and Uncertainty.” Journal of Finance, 40 (07 1985), 637–657.Google Scholar
Singer, R. F. “Endogenous Marginal Income Tax Rate, Investor Behavior and the Capital Asset Pricing Model.” Journal of Finance, 34, (06 1979), 609–616.Google Scholar