An analytical model of required returns to equity under taxation with imperfect loss offset
Lund (2002a) showed in a CAPM-type model how tax depreciation schedules affect required expected returns after taxes. Even without leverage higher tax rates implied lower betas when tax deductions were risk free. Here they are risky, and marginal investment is taxed together with inframarginal in an analytical model of decreasing returns. With imperfect loss offset tax claims are analogous to call options. The beta of equity is still decreasing in the tax rate, but increasing in the underlying volatility. The results are important if market data are used to infer required expected returns, and in discussions of tax design.
|Date of creation:||15 May 2005|
|Date of revision:|
|Publication status:||Published as Lund, Diderik, 'How taxes on firms reduce the risk of after-tax cash flows' in FinanzArchiv/Public Finance Analysis, 2014, pages 567-598.|
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