Capital Gains Taxes and the Risk-Return Tradeoff

61 Pages Posted: 7 Mar 2010 Last revised: 22 Sep 2012

See all articles by Zhonglan Dai

Zhonglan Dai

University of Texas at Dallas - School of Management

Douglas A. Shackelford

University of North Carolina Kenan-Flagler Business School; National Bureau of Economic Research (NBER)

Harold H. Zhang

University of Texas at Dallas - Naveen Jindal School of Management; China Academy of Financial Research (CAFR)

Date Written: March 5, 2010

Abstract

We derive cross-sectional implications of a capital gains tax rate change on the risk-return tradeoff on stock investment and show that stocks with higher accrued capital gains experience a larger risk-return tradeoff improvement after a capital gains tax rate cut. Stocks with higher dividend yields experience a larger increase (decrease) in the risk-return tradeoff when the dividend tax penalty effect dominates (is dominated by) the effect of reduced dividend yield associated with the capital gains tax cut. Studying both the Tax Relief Act of 1997 and the Revenue Act of 1978, we find stocks with higher accrued capital gains experienced larger increases in the expected return, the systematic risk, and the risk-return tradeoff after the capital gains tax cut. Stocks with higher dividend yields experienced larger decreases in the risk-return tradeoff, suggesting that the reduction in dividend yield associated with the capital gains tax cut may have dominated the dividend tax penalty effect.

Keywords: capital gains taxes, risk-return tradeoff, dividend yield, asset pricing

JEL Classification: H24, G12

Suggested Citation

Dai, Zhonglan and Shackelford, Douglas A. and Zhang, Harold Huibing, Capital Gains Taxes and the Risk-Return Tradeoff (March 5, 2010). Available at SSRN: https://ssrn.com/abstract=1565651 or http://dx.doi.org/10.2139/ssrn.1565651

Zhonglan Dai

University of Texas at Dallas - School of Management ( email )

2601 North Floyd Road
Richardson, TX 75083
United States

Douglas A. Shackelford (Contact Author)

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States
919-962-3197 (Phone)
919-962-4727 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Harold Huibing Zhang

University of Texas at Dallas - Naveen Jindal School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States

China Academy of Financial Research (CAFR)

1954 Huashan Road
Shanghai P.R.China, 200030
China

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