An Analytical Model of Required Returns to Equity Under Taxation with Imperfect Loss Offset

38 Pages Posted: 12 May 2004

See all articles by Diderik Lund

Diderik Lund

University of Oslo - Department of Economics

Date Written: October 13, 2003

Abstract

Lund (2002a) showed in a CAPM-type model how tax depreciation schedules affect required expected returns after taxes. Even without leverage, higher tax rates implied lower betas when tax deductions were risk free. Here they are risky, and marginal investment is taxed together with inframarginal in an analytical model of decreasing returns. With imperfect loss offset, tax claims are analogous to call options. The beta of equity is still decreasing in the tax rate but increasing in the underlying volatility. The results are important if market data are used to infer required expected returns and in discussions of tax design.

Keywords: Corporate tax, depreciation, imperfect loss offset, cost of capital, uncertainty

JEL Classification: F23, G31, H25

Suggested Citation

Lund, Diderik, An Analytical Model of Required Returns to Equity Under Taxation with Imperfect Loss Offset (October 13, 2003). Available at SSRN: https://ssrn.com/abstract=498543 or http://dx.doi.org/10.2139/ssrn.498543

Diderik Lund (Contact Author)

University of Oslo - Department of Economics ( email )

P.O. Box 1095 Blindern
Oslo, NO-0317
Norway
+47 22855129 (Phone)
+47 22855035 (Fax)

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