Optimal bond trading with personal taxes

Abstract Tax considerations governing bondholders' optimal trading include: capital loss realization; capital gain deferment; change of the long-term holding period status to short-term by sale of the bond and repurchase, to realize future losses short-term; raising the basis above par by sale of the bond and repurchase, to deduct the amortized premium from ordinary income. The optimal policy which incorporates transactions costs and conforms to the IRS code substantially differs from the buy-and-hold and continuous-realization policies. Failure to account for optimal trading may seriously bias econometric estimation of the yield curve and the tax bracket of the marginal bondholders.

[1]  Merton H. Miller,et al.  DEBT AND TAXES , 1977 .

[2]  S. Schaefer,et al.  Measuring a Tax-Specific Term Structure of Interest Rates in the Market for British Government Securities , 1981 .

[3]  E. A. Dyl,et al.  CAPITAL GAINS TAXATION AND YEAR‐END STOCK MARKET BEHAVIOR , 1977 .

[4]  Douglas T. Breeden.  An Intertemporal Asset Pricing Model with Stochastic Consumption and Investment Opportunities , 1979 .

[5]  Ben S. Branch.  A Tax Loss Trading Rule , 1977 .

[6]  Myron S. Scholes,et al.  Optimal Liquidation of Assets in the Presence of Personal Taxes: Implications for Asset Pricing , 1980 .

[7]  Myron S. Scholes,et al.  Dividends and taxes , 1978 .

[8]  John Caks.  THE COUPON EFFECT ON YIELD TO MATURITY , 1977 .

[9]  J. McCulloch,et al.  THE TAX-ADJUSTED YIELD CURVE , 1975 .

[10]  J. Ingersoll,et al.  Optimal Bond Trading with Personal Taxes: Implications for Bond Prices and Estimated Tax Brackets and Yield Curves , 1983 .

[11]  S. Schaefer,et al.  Tax-induced clientele effects in the market for British government securities : Placing bounds on security values in an incomplete market , 1982 .

[12]  F. Black,et al.  The Pricing of Options and Corporate Liabilities , 1973, Journal of Political Economy.

[13]  Stephen A. Ross,et al.  An Analysis of Variable Rate Loan Contracts , 1980 .

[14]  R. Banz,et al.  The relationship between return and market value of common stocks , 1981 .

[15]  Hans R. Stoll,et al.  Transaction costs and the small firm effect , 1983 .

[16]  G. William Schwert,et al.  Size and stock returns, and other empirical regularities , 1983 .

[17]  R. Litzenberger,et al.  Arbitrage pricing, transaction costs and taxation of capital gains: A study of government bonds with the same maturity date , 1984 .

[18]  Gordon B. Pye.  On the Tax Structure of Interest Rates , 1969 .

[19]  A. A. Robichek,et al.  Tax-Induced Bias in Reported Treasury Yields , 1970 .

[20]  George M. Constantinides,et al.  Capital Market Equilibrium with Personal Tax , 1983 .

[21]  R. Litzenberger,et al.  An International Study of Tax Effects on Government Bonds , 1984 .

[22]  S. Ross,et al.  A theory of the term structure of interest rates'', Econometrica 53, 385-407 , 1985 .

[23]  B. Grigelionis,et al.  On Stefan’s Problem and Optimal Stopping Rules for Markov Processes , 1966 .

[24]  Roger G. Ibbotson,et al.  Stocks, bonds, bills, and inflation : the past and the future , 1982 .

[25]  S. Ross,et al.  Option pricing: A simplified approach☆ , 1979 .

[26]  Sidney B. Wachtel.  Certain Observations on Seasonal Movements in Stock Prices , 1942 .

[27]  R. C. Merton,et al.  AN INTERTEMPORAL CAPITAL ASSET PRICING MODEL , 1973 .

[28]  S. Ross,et al.  A Re‐examination of Traditional Hypotheses about the Term Structure of Interest Rates , 1981 .

[29]  P. Schultz,et al.  Transaction costs and the small firm effect: A comment , 1983 .