Capital Market Equilibrium with Differential Taxation

34 Pages Posted: 11 Aug 1998

See all articles by Suleyman Basak

Suleyman Basak

London Business School; Centre for Economic Policy Research (CEPR)

Michael F. Gallmeyer

University of Virginia (UVA) - McIntire School of Commerce

Date Written: October 2002

Abstract

This paper studies the dynamics of equilibrium security prices when agents face differential dividend taxation. We construct a continuous-time equilibrium via a representative agent with stochastic weights. Agents differ in their pricing of risk inducing agent-specific consumption-based CAPMs, with differential taxation appearing as an additional factor. The interest rate, stock price, and consumption dynamics are also impacted. Under logarithmic preferences, risk is transferred from the higher-taxed to the lower-taxed agent, and the interest rate decreases to counteract extra precautionary savings against this suboptimally shared risk. Numerical analysis reveals further tax rate, time-to-horizon, and dividend risk effects. For most wealth allocations, the stock return volatility is increased above the no-tax benchmark.

JEL Classification: G12

Suggested Citation

Basak, Suleyman and Gallmeyer, Michael F., Capital Market Equilibrium with Differential Taxation (October 2002). London Business School, Working Paper Series Number 369. Available at SSRN: https://ssrn.com/abstract=98664 or http://dx.doi.org/10.2139/ssrn.98664

Suleyman Basak (Contact Author)

London Business School ( email )

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HOME PAGE: http://www.suleymanbasak.com

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Michael F. Gallmeyer

University of Virginia (UVA) - McIntire School of Commerce ( email )

P.O. Box 400173
Charlottesville, VA 22904-4173
United States
434-243-4043 (Phone)
434-924-7074 (Fax)

HOME PAGE: http://www.commerce.virginia.edu/faculty_research/facultydirectory/Pages/Gallmeyer.aspx

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