Cash Stream Valuation in the Face of Transaction Costs and Taxes

24 Pages Posted: 18 Apr 2008

See all articles by Robert A. Jarrow

Robert A. Jarrow

Cornell University - Samuel Curtis Johnson Graduate School of Management

Dilip B. Madan

University of Maryland

Abstract

The usual notion of every future cash stream having a net present value determined from a single term structure breaks down when transaction costs are taken into account, especially the sizable costs associated with short-borrowing. the difficulties are compounded by taxes, which can lead to paradoxes of disequilibrium if elementary NPV is assumed to be a rational basis for decision making. This paper systematically develops a theory of valuation which overcomes these shortcomings by accepting the multiplicity of no-arbitrage term structures that may be present for each tax class of investors, and uses the entire set of them to impute both a long price and a short price for every cash stream, regardless of the sign of the future payments. the valuation operators giving these prices are nonlinear but readily calculated from linear programming formulas.

Suggested Citation

Jarrow, Robert A. and Madan, Dilip B., Cash Stream Valuation in the Face of Transaction Costs and Taxes. Mathematical Finance, Vol. 1, Issue 3, pp. 31-43, July 1991, Available at SSRN: https://ssrn.com/abstract=1122042 or http://dx.doi.org/10.1111/j.1467-9965.1991.tb00003.x

Robert A. Jarrow (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Department of Finance
Ithaca, NY 14853
United States
607-255-4729 (Phone)
607-254-4590 (Fax)

Dilip B. Madan

University of Maryland

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