Immunization in Markets with Tax-Clientele Effects: Evidence from the Canadian Market

Eliezer Z. Prisman and Yisong Tian

Journal of Financial and Quantitative Analysis, 1994, vol. 29, issue 2, 301-321

Abstract: Empirical immunization studies have considered the efficacy of immunization strategies, in which the durations of assets and of liabilities are equated, against a strategy involving maturity matching. However, all these studies have ignored tax effects. In the presence of tax-clientele effects, immunization requires that the portfolio consists only of bonds that are correctly priced for a particular clientele. Testing for these effects, therefore, requires the identification of the correctly priced bonds for the investors in the clientele. However, since bond prices contain noise, determining these bonds is still an unresolved problem. Consequently, an empirical test of the magnitude of the error caused by ignoring taxes may be an impossible task in some markets, and indeed has never been conducted. The Canadian bond market provides perfect laboratory conditions for such a test. Tax-clientele effects are present in the Canadian market, and among the clienteles is a representative clientele. This paper examines the tax effects on immunization strategies. The results show that the error caused by ignoring tax effects is not negligible, and practitioners should use immunization with reference to tax effects.

Date: 1994
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