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The demand for tax-favored risky assets with capital gains tax exclusions, tax policy uncertainty, and its implications for pricing

Author

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  • Davis, Yehuda
  • Govindaraj, Suresh
  • Tejas, Tavish

Abstract

We develop a model to examine how rational risk-averse individuals react and rearrange their consumption and investment choices in the presence of tax exclusions on the returns from risky assets that exclude a fixed amount of capital gains from taxation. We are specifically interested in the implications and efficacy of these special kinds of tax incentives that are commonly used to encourage investments in risky assets internationally. We also allow for tax rate uncertainty. We show that the effects of these tax exclusions on investors are nuanced and may not always achieve the desired policy objective of stimulating higher investments in risky assets. We identify the endogenously computed regions with shared common boundaries where increasing capital gains tax exclusions will stimulate higher demand for risky assets, have no effect on demand at all, or even have an opposite effect by reducing demand. While our results apply to tax exclusions in general, we provide two specific examples using (i) data from the United States housing market, and (ii) the United Kingdom stock market, for a CRRA investor. We also provide insights on the pricing and related issues for these tax-favored risky assets.

Suggested Citation

  • Davis, Yehuda & Govindaraj, Suresh & Tejas, Tavish, 2025. "The demand for tax-favored risky assets with capital gains tax exclusions, tax policy uncertainty, and its implications for pricing," Journal of Corporate Finance, Elsevier, vol. 94(C).
    • Handle: RePEc:eee:corfin:v:94:y:2025:i:c:s0929119925000823
    DOI: 10.1016/j.jcorpfin.2025.102814
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    Keywords

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    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • R38 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Real Estate Markets, Spatial Production Analysis, and Firm Location - - - Government Policy

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