Estimating the Tax-Timing Option Value of Corporate Bonds

Peter Huaiyu Chen, Sheen Liu and Chunchi Wu

Chapter 128 in Handbook of Financial Econometrics, Mathematics, Statistics, and Machine Learning:(In 4 Volumes), 2020, pp 4383-4419 from World Scientific Publishing Co. Pte. Ltd.

Abstract: US tax laws provide investors an incentive to time the sales of their bonds to minimize tax liability. This grants a tax timing option that affects bond value. In reality, corporate bond investors’ tax-timing strategy is complicated by risk of default. In this chapter, we assess the effects of taxes and stochastic interest rates on the timing option value and equilibrium price of corporate bonds by considering discount and premium amortization, multiple trading dates, transaction costs, and changes in the level and volatility of interest rates. We find that the value of tax-timing option account for a substantial proportion of corporate bond price and the option value increases with bond maturity and credit risk.

Keywords: Financial Econometrics; Financial Mathematics; Financial Statistics; Financial Technology; Machine Learning; Covariance Regression; Cluster Effect; Option Bound; Dynamic Capital Budgeting; Big Data (search for similar items in EconPapers)
JEL-codes: C01 C1 G32 (search for similar items in EconPapers)
Date: 2020
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