Hedging in an Economy with Asymmetric Taxes: A Comment on Moshe Ayre Milevsky & Eliezer Z. Prisman, Hedging and Pricing with Tax Law Uncertainty: Managing Under an Arkansas Best Doctrine
Annual Proceedings of the Chicago Board of Trade
Posted: 17 Feb 1999
This comment describes how to construct a hedging portfolio when the derivatives used to construct the hedge are taxed as capital assets and then compares the after-tax cost of that hedge to the cost of assembling a hedging portfolio when derivatives are taxed as ordinary assets. The former hedge is identical to the hedge that Professors Milevsky and Prisman offer as the most efficient hedge against the risk that a hedge will be taxed as a capital asset. This comment then shows that hedging produces a tax benefit when hedges are definitely taxed as ordinary assets, but it has a tax cost when they are definitely taxed as capital assets. This comment also argues that even if hedges are definitely taxed as capital assets, taxpayers can effectively receive ordinary tax treatment by embedding them in contingent debt.
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