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Capital Gains Taxes and Asset Prices: Capitalization or Lock-in?

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  • ZHONGLAN DAI
  • EDWARD MAYDEW
  • DOUGLAS A. SHACKELFORD
  • HAROLD H. ZHANG

Abstract

This paper demonstrates that the equilibrium impact of capital gains taxes reflects both the capitalization effect (i.e., capital gains taxes decrease demand) and the lock-in effect (i.e., capital gains taxes decrease supply). Depending on time periods and stock characteristics, either effect may dominate. Using the Taxpayer Relief Act of 1997 as our event, we find evidence supporting a dominant capitalization effect in the week following news that sharply increased the probability of a reduction in the capital gains tax rate and a dominant lock-in effect in the week after the rate reduction became effective. Copyright 2008 by The American Finance Association.

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Bibliographic Info

Article provided by American Finance Association in its journal The Journal of Finance.

Volume (Year): 63 (2008)
Issue (Month): 2 (04)
Pages: 709-742

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Handle: RePEc:bla:jfinan:v:63:y:2008:i:2:p:709-742

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  1. Guenther, David A. & Willenborg, Michael, 1999. "Capital gains tax rates and the cost of capital for small business: evidence from the IPO market," Journal of Financial Economics, Elsevier, vol. 53(3), pages 385-408, September.
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  10. Benjamin C. Ayers & Craig E. Lefanowicz & John R. Robinson, 2003. "Shareholder Taxes in Acquisition Premiums: The Effect of Capital Gains Taxation," Journal of Finance, American Finance Association, vol. 58(6), pages 2783-2801, December.
  11. Jennifer L. Blouin & Jana Smith Raedy & Douglas A. Shackelford, 2003. "Capital Gains Taxes and Equity Trading: Empirical Evidence," Journal of Accounting Research, Wiley Blackwell, vol. 41(4), pages 611-651, 09.
  12. Li Jin, 2006. "Capital Gains Tax Overhang and Price Pressure," Journal of Finance, American Finance Association, vol. 61(3), pages 1399-1431, 06.
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  14. Constantinides, George M, 1983. "Capital Market Equilibrium with Personal Tax," Econometrica, Econometric Society, vol. 51(3), pages 611-36, May.
  15. Klein, Peter, 1999. "The capital gain lock-in effect and equilibrium returns," Journal of Public Economics, Elsevier, vol. 71(3), pages 355-378, March.
  16. George M. Constantinides, 1983. "Optimal Stock Trading with Personal Taxes: Implications for Prices and the Abnormal January Returns," NBER Working Papers 1176, National Bureau of Economic Research, Inc.
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