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Optimal Bond Trading with Tax Clienteles: A Discrete‐Time Dynamic Trading Model
Author(s) -
Tian Yisong
Publication year - 1996
Publication title -
financial review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.621
H-Index - 47
eISSN - 1540-6288
pISSN - 0732-8516
DOI - 10.1111/j.1540-6288.1996.tb00875.x
Subject(s) - economics , monetary economics , tax credit , differential (mechanical device) , bond , bond valuation , microeconomics , financial economics , business , interest rate , finance , public economics , engineering , aerospace engineering
This study develops a discrete‐time dynamic trading model for bond pricing under differential taxation. The model incorporates both the tax‐timing option effect and the tax‐clientele effect. Investors from all tax brackets have a chance to bid for a bond, and the marginal investor is the one who is willing to pay the highest price. Simulation results show that inter‐bracket trading occurs frequently as the interest rate changes, which enhances the value of the tax option. These results are shown to be robust to changes in interest rate process and tax regimes.