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Taxation and Bond Market Equilibrium in a World of Uncertain Future Interest Rates: Reply

Published online by Cambridge University Press:  06 April 2009

Miles Livingston
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Extract

Models of security markets invariably assume that market participants act intelligently since any other assumption generally leads to absurd results. Schaefer's Comment makes the incorrect assumption that one market participant, namely the government, acts unintelligently by allowing investors to reap tax arbitrage profits. Consequently, the conclusions in the Comment are erroneous. As I will show below, a government can (and the U.S. Government does) prevent tax arbitrage and any resulting disequilibrium in the bond market through two simple tax rules. My earlier paper [1] primarily showed that bond price must be a linear function of coupon for any maturity under the assumption of constant tax brackets for all investors, and then suggested that a linear relationship will also hold with investors in different tax brackets. I will prove this last result below.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 16 , Issue 5 , December 1981 , pp. 779 - 781
Copyright
Copyright © School of Business Administration, University of Washington 1981

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References

REFERENCES

[1]Livingston, M. “Taxation and Bond Market Equilibrium in a World of Uncertain Future Interest Rates.” Journal of Financial and Quantitative Analysis (03 1979), pp. 11–27.CrossRefGoogle Scholar
[2]Livingston, M. “Taxation and the Shape of the Bond Yield to Maturity Curve.” Journal of Finance (03 1979), pp. 189–196.Google Scholar
[3]Livingston, M. “A Note on the Issuance of Long-Term Pure Discount Notes.” Journal of Finance (03 1979), pp. 241–246.Google Scholar
[4]Livingston, M. “ThePricing of Premium Bonds.” Journal of Financial and Quantitative Analysis (09 1979), pp. 517–527.CrossRefGoogle Scholar
[5]Miller, M. “Debt and Taxes.” Journal of Finance (05 1977), pp. 261–275.Google Scholar
[6]Miller, M., and Scholes, M.. “Dividends and Taxes.” Journal of Financial Economics (12 1978), pp. 333–364.CrossRefGoogle Scholar