The Capitalization Effect of Imputation Credits on Expected Stock Returns

Abstract

This paper develops an equilibrium model featuring heterogeneity in investor risk tolerance across different risk sources. Using Australian data, it confirms the theoretical predictions of the model, by showing that a higher imputation credit yield in one year leads to a lower stock return in the next year, and this negative relationship between imputation credit yield and stock return is weaker for stocks with higher idiosyncratic risk, of larger size and with a higher trading turnover. Our theoretical and empirical evidence favours the aggregation approach in explaining the capitalization effect of imputation credits over the marginal investor approach.

Keywords: Dividend imputation; Taxation; Stock returns; Risk tolerance

JEL Classification: G10, G12, H20, M40