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Taxation And Transaction Costs In A General Equilibrium Asset Economy

Author

Listed:
  • Frank Milne

    () (Queen's University)

  • Xing Jin

    (University of Warwick)

Abstract

Most financial asset pricing models assume frictionless, competitive markets that imply the absence of arbitrage opportunities. Given the absence of arbitrage opportunities and complete asset markets, there exists a unique martingale measure that implies martingale pricing formulae and replicating asset portfolios. In incomplete markets, or markets with transaction costs, these results must be modified to admit non-unique measures and the possibility of imperfectly replicating portfolios. Similar difficulties arise in markets with taxation. Some theoretical research has argued that some taxation functions will imply arbitrage opportunities and the non-existence of a competitive asset economy. In this paper we construct a multi-period, discrete time/state general equilibrium model of asset markets with transaction costs and taxes. The transaction cost technology and the tax system are quite general, so that we can include most discrete time/state models with transaction costs and taxation. We show that a competitive equilibrium exists. Our results require careful modeling of the government budget constraints to rule out tax arbitrage possibilities.

Suggested Citation

  • Frank Milne & Xing Jin, 2006. "Taxation And Transaction Costs In A General Equilibrium Asset Economy," Working Paper 1111, Economics Department, Queen's University.
  • Handle: RePEc:qed:wpaper:1111
    as

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    File URL: https://www.econ.queensu.ca/sites/econ.queensu.ca/files/wpaper/qed_wp_1111.pdf
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    References listed on IDEAS

    as
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    4. Frank Milne & Edwin H. Neave, 2003. "A General Equilibrium Financial Asset Economy With Transaction Costs And Trading Constraints," Working Paper 1082, Economics Department, Queen's University.
    5. Jérôme Detemple & Shashidhar Murthy, 1997. "Equilibrium Asset Prices and No-Arbitrage with Portfolio Constraints," CIRANO Working Papers 97s-12, CIRANO.
    6. Xing Jin & Frank Milne, 1999. "The Existence Of Equilibrium In A Financial Market With Transaction Costs," World Scientific Book Chapters, in: Marco Avellaneda (ed.), Quantitative Analysis In Financial Markets Collected Papers of the New York University Mathematical Finance Seminar, chapter 14, pages 323-343, World Scientific Publishing Co. Pte. Ltd..
    7. Duffie, Darrell, 1987. "Stochastic equilibria with incomplete financial markets," Journal of Economic Theory, Elsevier, vol. 41(2), pages 405-416, April.
    8. Dammon, Robert M & Green, Richard C, 1987. "Tax Arbitrage and the Existence of Equilibrium Prices for Financial Assets," Journal of Finance, American Finance Association, vol. 42(5), pages 1143-1166, December.
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    More about this item

    Keywords

    General Equilibrium; Transaction Costs; Taxation; Asset Economy;
    All these keywords.

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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