Optimal Liquidation of Assets in the Presence of Personal Taxes: Implications for Asset Pricing

Call options and commodity futures contracts can be used to construct hedged positions such that tax payments on capital gains from investments may be deferred indefinitely. The only factor that can moderate the effectiveness of the hedge is transaction costs. Tax loopholes are created because of th...

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Bibliographic Details
Published in:The Journal of finance (New York) 1980-05, Vol.35 (2), p.439-449
Main Authors: CONSTANTINIDES, GEORGE M., SCHOLES, MYRON S.
Format: Article
Language:English
Subjects:
Assets
Call options
Capital gains
Capital gains taxes
Capital losses
Commodity futures
Deferred taxes
Hedging
Impacts of Taxes on Financial Decisions
Income taxes
Investments
Investors
Liquidation
Optimization
Put & call options
Stock prices
Strike prices
Tax planning
Tax rates
Taxes
Transaction costs
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Summary:Call options and commodity futures contracts can be used to construct hedged positions such that tax payments on capital gains from investments may be deferred indefinitely. The only factor that can moderate the effectiveness of the hedge is transaction costs. Tax loopholes are created because of the institutional structure of the options exchange and commodity futures exchange. The fact that this type of mechanism exists complicates analysis of the ''optimal investor behavior''. This concept can be expressed mathematically in a function that relates: 1. the stock price of a call option, 2. the exercise price of the option, 3. maturity date, and 4. specific date. The impact of taxes and the ability to defer taxes can also be depicted in terms of investor welfare. Several key factors that relate to investor welfare are: 1. inflation, 2. tax rates, 3. dividends, and 4. stock return variability. For example, if inflation increases, investor welfare decreases because nominal capital gains are taxed.
ISSN:0022-1082
1540-6261
DOI:10.1111/j.1540-6261.1980.tb02174.x