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Tax asymmetry and futures hedging under liquidity constraints

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  • Kit Pong Wong

    (School of Economics and Finance, University of Hong Kong, Hong Kong)

Abstract

This paper examines the optimal futures hedging decision of a firm facing uncertain income that is subject to asymmetric taxation with no loss-offset provisions. All futures contracts are marked to market and require interim cash settlement of gains and losses. The firm is liquidity constrained in that it is forced to prematurely close its futures position on which the interim loss incurred exceeds a threshold level. The liquidity risk created by the interim funding requirement of a futures hedge is shown to proffer the firm perverse incentives, thereby making an under-hedge optimal. This under-hedging result holds irrespective of whether the firm is risk neutral or risk averse. Copyright © 2005 John Wiley & Sons, Ltd.

Suggested Citation

  • Kit Pong Wong, 2005. "Tax asymmetry and futures hedging under liquidity constraints," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 26(4), pages 271-281.
    • Handle: RePEc:wly:mgtdec:v:26:y:2005:i:4:p:271-281
    DOI: 10.1002/mde.1223
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    References listed on IDEAS

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    Cited by:

    1. Fu, Junhui, 2014. "Multi-objective hedging model with the third central moment and the capital budget," Economic Modelling, Elsevier, vol. 36(C), pages 213-219.

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