Asset Prices in the Presence of a Tax Authority

Marc Rapp and Bernhard Schwetzler
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Marc Rapp: Leipzig Graduate School of Management (HHL)
Bernhard Schwetzler: Leipzig Graduate School of Management (HHL)

No 2006-1-1167, German Working Papers in Law and Economics from Berkeley Electronic Press

Abstract: This paper examines the equilibrium effect of a shift in the capital income tax rate upon state prices, risk-neutral probabilities, and corresponding security prices in a single-period binomial model economy with an exogenous risk-free rate. The policy design under consideration consists of a simple linear tax code that applies the economic rent as a tax base. It is shown that if tax proceeds are transferred to outsiders, a shift in the tax rate affects state prices, risk-neutral probabilities as well as equilibrium security prices. Thereby, the effect for the equilibrium price of a security is sensitive with respect to the correlation between its own payoff and the payoff of the market portfolio. If in contrast tax proceeds are redistributed within the cohort of market participants, risk-neutral probabilities, and security prices are unaffected by a change in the tax rate, although state prices are sensitive with respect to the tax rate.

Keywords: Equilibrium security prices; capital income tax; risk-neutral probability measure (search for similar items in EconPapers)
JEL-codes: D50 G12 G31 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-acc, nep-cfn, nep-fmk and nep-law
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