Taxation Under Uncertainty - Problems of Dynamic Programming and Contingent Claims Analysis in Real Option Theory

29 Pages Posted: 16 May 2002

See all articles by Rainer Niemann

Rainer Niemann

University of Graz, Center for Accounting Research; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Caren Sureth-Sloane

Paderborn University; Vienna University of Economics and Business; TRR 266 Accounting for Transparency

Date Written: April 2002

Abstract

This article deals with the integration of taxes into real option-based investment models under risk neutrality and risk aversion. It compares two possible approaches -- dynamic programming and contingent claims analysis -- to analyze their effects on the optimal investment rules before and after taxes. It can be shown that despite their different assumptions, dynamic programming and contingent claims analysis yield identical investment thresholds under risk neutrality. In contrast, under risk aversion, there are severe problems in determining an adequate risk-adjusted discount rate. The application of contingent claims analysis is restricted to cases with a dividend rate unaffected by risk. Therefore, only dynamic programming permits an explicit investment threshold without taxation. After taxes, both approaches fail to reach general solutions. Nevertheless, using a sufficient condition, it is possible to derive neutral tax systems under risk aversion as is demonstrated by using dynamic programming.

JEL Classification: H25, H21

Suggested Citation

Niemann, Rainer and Sureth-Sloane, Caren, Taxation Under Uncertainty - Problems of Dynamic Programming and Contingent Claims Analysis in Real Option Theory (April 2002). Available at SSRN: https://ssrn.com/abstract=312131 or http://dx.doi.org/10.2139/ssrn.312131

Rainer Niemann (Contact Author)

University of Graz, Center for Accounting Research ( email )

Universitätsstr. 15 / G2
Graz, 8010
Austria
+43-316-380-6444 (Phone)
+43-316-380-9595 (Fax)

HOME PAGE: http://www.uni-graz.at/steuer

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Poschinger Str. 5
Munich, DE-81679
Germany

Caren Sureth-Sloane

Paderborn University ( email )

Warburger Str. 100
Paderborn, 33098
Germany

Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien 1020
Austria

TRR 266 Accounting for Transparency ( email )

Warburger Straße 100
Paderborn, 33098
Germany

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