Capital Market Equilibrium with Differential Taxation

This paper studies the eect,of investor-specific dierential,dividend taxation on the dy- namics of equilibrium security prices and allocations. In order to deal with the inherent Pareto ineciency,of such an equilibrium as well as the preclusion of tax arbitrage, we construct a continuous-time equilibrium via a representative investor with state-dependent utility. In- vestors dier,in their pricing of risk, inducing investor-specific consumption-based CAPMs, with dierential taxation appearing as an additional factor. The interest rate, stock price, and consumption dynamics are also impacted. Under logarithmic preferences, risk is transferred from the higher-taxed to the lower-taxed investor, and the interest rate decreases to counteract