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

Author

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  • Jaroslava Hlouskova

    (Institute for Advanced Studies, Vienna, Austria and Thompson Rivers University, Kamloops, British Columbia, Canada)

  • Jana Mikocziova

    (University of Economics in Bratislava, Slovakia)

  • Rudolf Sivak

    (University of Economics in Bratislava, Slovakia)

  • Peter Tsigaris

    (Thompson Rivers University, Kamloops, British Columbia, Canada)

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.

Suggested Citation

  • Jaroslava Hlouskova & Jana Mikocziova & Rudolf Sivak & Peter Tsigaris, 2014. "Capital Income Taxation and Risk-Taking under Prospect Theory: The Continuous Distribution Case," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 64(5), pages 374-391, November.
  • Handle: RePEc:fau:fauart:v:64:y:2014:i:5:p:374-391
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    References listed on IDEAS

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    Cited by:

    1. Ines Fortin & Jaroslava Hlouskova, 2015. "Downside loss aversion: Winner or loser?," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 81(2), pages 181-233, April.
    2. Mehrmann, Annika & Sureth-Sloane, Caren, 2017. "Tax loss offset restrictions and biased perception of risky investments," arqus Discussion Papers in Quantitative Tax Research 222, arqus - Arbeitskreis Quantitative Steuerlehre.
    3. Hlouskova, Jaroslava & Tsigaris, Panagiotis, 2020. "Capital income taxation under full loss offset provisions of a prospect theory investor," IHS Working Paper Series 11, Institute for Advanced Studies.

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    More about this item

    Keywords

    risk-taking; portfolio choice; prospect theory; loss aversion; reference level; taxation;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • H2 - Public Economics - - Taxation, Subsidies, and Revenue

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