Valuation before and after tax in the discrete time, finite state no arbitrage model

Jensen, Bjarne Astrup

doi:10.1007/s10436-007-0091-1

Cited by 7 publications

(9 citation statements)

References 24 publications

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“…A thorough treatment of differential personal taxation in general no-arbitrage models remains a challenge and is beyond the scope of this endeavor (see, however, Jensen, 2009;and Gamba et al, 2008).…”

Section: (D) Operating Asset Relation (Oar)mentioning

confidence: 98%

Equity Valuation

Christensen

Feltham

2009

FNT in Accounting

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Section: (D) Operating Asset Relation (Oar)mentioning

confidence: 98%

Equity Valuation

Christensen

Feltham

2009

FNT in Accounting

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“…While Ross [23] and Dammon and Green [5] mainly study price-independent tax systems, our focus is on taxation that depends on prices with the option to defer. For a complementary analysis of a mark-tomarket tax system without the possibility of deferrals, see Jensen [20]. Our current analysis is also formulated in a setting with no trading restrictions such as a short-sale constraint.…”

Section: Introductionmentioning

confidence: 98%

“…From the wash sale constraint,y(0) = y(u) = z 0 (u) = 0. Rearranging(20) and letting ω 2 = u, we haveW (u, u) = − S(0)(u 2 (1 − τ ) − R 2 f + τ )1 z(0) − τ (R 2 f − 1)(S(0)1 − b(0)) z(0) − S(0)u(u(1 − τ ) − R f + τ )1 z(u) − τ (R f − 1)(S(0)u1 − b(0)) z(u).…”

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confidence: 99%

Arbitrage and the tax code

Gallmeyer

Srivastava

2011

Math Finan Econ

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We provide a detailed characterization of arbitrage-free asset prices in the presence of capital gains and income taxes. The distinguishing feature of our analysis is that we impose on the model two important features of the tax code: the limited use of capital losses and the inability to wash sell. We show that under remarkably mild conditions, the lack of pre-tax arbitrage implies the lack of post-tax arbitrage with the limited use of capital losses. The conditions are that the risk free interest rate be positive and that tax rates on interest income exceed capital gains tax rates. The result also holds when only a wash sale constraint is imposed and no investor holds a portfolio with a large capital loss. We allow investors to face different tax rates and have different bases for the calculation of capital gains taxes. The characterizations we provide have important implications for both asset pricing and portfolio choice. Our results imply that models that use arbitrage-free pre-tax models continue for derivative pricing and hedging are also arbitrage free in a world with taxes. Similarly, portfolio choice models with taxes typically specify pre-tax arbitrage free price processes and then analyze portfolio choice in the presence of taxes. In these models, it is unclear if portfolio recommendations are based on risk-return tradeoffs or on the arbitrage opportunities present in the model. Our results imply that if the above features of the tax code are modeled explicitly, then we can isolate the post-tax risk-return tradeoffs.

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“…, T } with V (N ) ≥ 0, cf.(3.4). From (4 14). it follows that N s,u−1 (ω 2 ) − N s,u (ω 2 ) = 0 for all s < u and thus N s,s (ω 2 ) = T u=s+1 (N s,u−1 (ω 2 ) − N s,u (ω 2 )) = 0.…”

mentioning

confidence: 99%

How local in time is the no-arbitrage property under capital gains taxes?

Kühn

2018

Math Finan Econ

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In frictionless financial markets, no-arbitrage is a local property in time. This means that a discrete time model is arbitrage-free if and only if there does not exist a one-periodarbitrage. With capital gains taxes, this equivalence fails. For a model with a linear tax and one non-shortable risky stock, we introduce the concept of robust local no-arbitrage (RLNA) as the weakest local condition which guarantees dynamic no-arbitrage. Under a sharp dichotomy condition, we prove (RLNA). Since no-one-period-arbitrage is necessary for no-arbitrage, the latter is sandwiched between two local conditions, which allows us to estimate its non-locality.Furthermore, we construct a stock price process such that two long positions in the same stock hedge each other. This puzzling phenomenon that cannot occur in arbitrage-free frictionless markets (or markets with proportional transaction costs) is used to show that no-arbitrage alone does not imply the existence of an equivalent separating measure if the probability space is infinite.Finally, we show that the model with a linear tax on capital gains can be written as a model with proportional transaction costs by introducing several fictitious securities.

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Valuation before and after tax in the discrete time, finite state no arbitrage model

Abstract: Tax neutrality, Mark-to-market valuation, Generalized linear taxation schemes, Wash sales, G12, G13, H20,

Cited by 7 publications

References 24 publications

Equity Valuation

Equity Valuation

Arbitrage and the tax code

How local in time is the no-arbitrage property under capital gains taxes?

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