Capital Income Taxation and Risk-Taking under Prospect Theory: The Continuous Distribution Case

Jaroslava Hlouskova, Jana Mikocziova, Rudolf Sivak and Panagiotis Tsigaris ()
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Jana Mikocziova: University of Economics in Bratislava, Slovakia
Rudolf Sivak: University of Economics in Bratislava, Slovakia

Czech Journal of Economics and Finance (Finance a uver), 2014, vol. 64, issue 5, 374-391

Abstract: This study verifies whether the results of proportional capital income taxation on the risk-taking of a loss-averse investor will still hold when the return of a risky asset has a general continuous distribution. We extend the previous literature, which assumes a binomial distribution of asset returns for a risky asset. We also show that under reasonable assumptions risk-taking is finite and positive and thus a loss-averse investor will not choose infinite leverage despite no regulations being applied. In addition, unlike in the expected utility model, the capital income tax increase does not stimulate risk-taking when the reference level is the initial wealth or the gross after the tax return from investing the initial wealth into the risk-free asset. Furthermore, when investors set their reference level at the gross (pre-tax) return from investing the initial wealth into the risk-free asset, they increase not only risk-taking but also their private risks as measured by the standard deviation of their after-tax final wealth, which is not the case in the expected utility model.

Keywords: risk-taking; portfolio choice; prospect theory; loss aversion; reference level; taxation (search for similar items in EconPapers)
JEL-codes: G11 H2 (search for similar items in EconPapers)
Date: 2014
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:fau:fauart:v:64:y:2014:i:5:p:374-391

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