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Asset Prices in the Presence of a Tax Authority


  • Marc Rapp

    (Leipzig Graduate School of Management (HHL))

  • Bernhard Schwetzler

    (Leipzig Graduate School of Management (HHL))


This paper examines the equilibrium effect of a shift in the capital income tax rate upon state prices, risk-neutral probabilities, and corresponding security prices in a single-period binomial model economy with an exogenous risk-free rate. The policy design under consideration consists of a simple linear tax code that applies the economic rent as a tax base. It is shown that if tax proceeds are transferred to outsiders, a shift in the tax rate affects state prices, risk-neutral probabilities as well as equilibrium security prices. Thereby, the effect for the equilibrium price of a security is sensitive with respect to the correlation between its own payoff and the payoff of the market portfolio. If in contrast tax proceeds are redistributed within the cohort of market participants, risk-neutral probabilities, and security prices are unaffected by a change in the tax rate, although state prices are sensitive with respect to the tax rate.

Suggested Citation

  • Marc Rapp & Bernhard Schwetzler, "undated". "Asset Prices in the Presence of a Tax Authority," German Working Papers in Law and Economics 2006-1-1167, Berkeley Electronic Press.
  • Handle: RePEc:bep:dewple:2006-1-1167 Note: oai:bepress:

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    References listed on IDEAS

    1. Poterba, James M., 2002. "Taxation, risk-taking, and household portfolio behavior," Handbook of Public Economics,in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 3, chapter 17, pages 1109-1171 Elsevier.
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    5. Paul A. Samuelson, 1964. "Tax Deductibility of Economic Depreciation to Insure Invariant Valuations," Journal of Political Economy, University of Chicago Press, vol. 72, pages 604-604.
    6. Hong, Harrison & Kubik, Jeffrey D. & Stein, Jeremy C., 2008. "The only game in town: Stock-price consequences of local bias," Journal of Financial Economics, Elsevier, vol. 90(1), pages 20-37, October.
    7. Brennan, M. J. & Kraus, Alan, 1978. "Necessary Conditions for Aggregation in Securities Markets," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 13(03), pages 407-418, September.
    8. Ellen R. McGrattan & Edward C. Prescott, 2005. "Taxes, Regulations, and the Value of U.S. and U.K. Corporations," Review of Economic Studies, Oxford University Press, vol. 72(3), pages 767-796.
    9. Sandmo, Agnar, 1989. "Differential taxation and the encouragement of risk-taking," Economics Letters, Elsevier, vol. 31(1), pages 55-59.
    10. Roger H. Gordon, 1985. "Taxation of Corporate Capital Income: Tax Revenues Versus Tax Distortions," The Quarterly Journal of Economics, Oxford University Press, vol. 100(1), pages 1-27.
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    13. Margit Schratzenstaller, 2003. "Dualisierung von Einkommensteuersystemen: Stand und Perspektiven im internationalen Vergleich," Vierteljahrshefte zur Wirtschaftsforschung / Quarterly Journal of Economic Research, DIW Berlin, German Institute for Economic Research, vol. 72(4), pages 535-550.
    14. Litzenberger, Robert H & Ramaswamy, Krishna, 1980. " Dividends, Short Selling Restrictions, Tax-Induced Investor Clienteles and Market Equilibrium," Journal of Finance, American Finance Association, vol. 35(2), pages 469-482, May.
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    Cited by:

    1. Schosser, Josef, 2008. "Bewertung ohne "Kapitalkosten": Ein arbitragetheoretischer Ansatz zu Unternehmenswert, Kapitalstruktur und persönlicher Besteuerung," Passauer Diskussionspapiere, Betriebswirtschaftliche Reihe 13, University of Passau, Faculty of Business and Economics.

    More about this item


    Equilibrium security prices; capital income tax; risk-neutral probability measure;

    JEL classification:

    • D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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