Tax Specific Term Structures of Interest Rates in the UK Government Bond Market

Andrew Derry and Mahmood Pradhan

Bank of England working papers from Bank of England

Abstract: Coupon income and capital gain on UK Government bonds are taxed differently, so some investors do not regard all bonds as perfect substitutes. This paper examines the extent to which term structures of interest rates derived from the UK bond market are tax specific, using a linear programming technique to select the optimal portfolios for investors facing different tax treatment. Despite the tax reforms of the mid-nineteen eighties - designed to reduce arbitrage opportunities in the gilts market - divergences between yield curves of the main categories of tax payers are found to remain.

Date: 1993-04
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