Asset Pricing with Taxes: A Security Market Model Considering Demand Aggregation
Posted: 23 Jul 2004
Date Written: July 31, 2004
With respect to valuation there are two effects of taxation. On the one hand taxation directly affects the cash flows of an investment distributed to investors. On the other hand it indirectly affects the equilibrium pricing mechanism of the economy. Applying the consumption based asset pricing framework in a two-date security market model with heterogeneous agents we analyze the second effect. Establishing a tax authority with revenues (security income and consumption taxes) and expenditures (redistribution) enables the government to alter the wealth distribution of the economy. Allowing for frictions in this re-allocation process we discuss the implications for the equilibrium pricing mechanism. Introducing the concept of weak and strong invariance we present two invariance statements, one for economies with homogeneous agents and a second for economies satisfying the aggregation property. As an application we discuss two problems of coporate valuation. Especially we revisit the neutrality result of Samuelson (1964).
Keywords: Asset pricing, taxation, valuation, equilibrium
JEL Classification: D31, D51, G12, H24
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