the relation between tax rates and pre tax returns direct evidence from the 1981 and 1986 tax rate reductions abstract this study documents one effect of the theory of implicit taxes providing evidence that a change in the tax rate results in a change in pre tax returns yield spreads of pairs of treasury bills maturing in the last week of december and the first week of january are examined year ends not affected by rate changes show a significant positive yield spread between these pairs of bills reflecting an upward sloping yield curve however for year ends coinciding with the tax rate reductions of 1981 and 1986 there is a significant negative yield spread between these pairs of bills

complexity in structured finance we study complexity in the market for securitized products a market at the heart of the financial crisis of 2007 9 the complexity of these products rose substantially in the years preceding the financial crisis we find that securities in more complex deals default more and have lower realized returns the worse performance is economically meaningful a one standard deviation increase in complexity represents an 18 increase in default on aaa securities however yields of more complex securities are not higher indicating that investors did not perceive them as riskier our results are consistent with complexity obfuscating security quality

arbitrage clientele effects and the term structure of interest rates this paper derives a new and intuitive estimation procedure for the term structure under potential tax arbitrage no a priori assumptions regarding the equality of the prices and present values of bonds are made the data are employed to determine whether this equality holds and an appropriate estimator is thereby endogenously derived the suggested estimator is based on the optimizing behavior of an investor in a market with frictions and emerges directly from the solution of the dual of the no arbitrage optimization problem in addition the proposed estimator benefits from being both theoretically sound and straightforward to apply

drip pricing and its regulation experimental evidence abstract this article analyzes the effects of drip pricing the business practice of decomposing a price into multiple components that are presented sequentially to buyers we experimentally examine the effects of this practice on seller strategies and buyer behaviors and we assess the implications for regulation in our experiment sellers set two prices a base or headline price and a drip price at first buyers observe only the base prices and make a tentative purchase decision subsequently revealing the sellers drip prices however comes at a cost to buyers we find that sellers only compete on base prices and thus set the highest possible drip price this makes the base price a reliable indicator for the lowest total price moreover few consumers invest in drip price searches a comparison with bertrand competition reveals significant effects with drip pricing consumer surplus is lower and seller profits are higher when there is uncertainty over possible drip sizes sellers also compete over drips and consumers more frequently fail to identify the cheapest offer bertrand competition also leads to higher consumer surplus and lower firm profits in this case hence our results point to positive effects of drip price regulation

strategic price complexity in retail financial markets abstract there is mounting empirical evidence to suggest that the law of one price is violated in retail financial markets there is significant price dispersion even when products are homogeneous also despite the large number of firms in the market prices remain above marginal cost and may even rise as more firms enter in a non cooperative oligopoly pricing model i show that these anomalies arise when firms add complexity to their price structures complexity increases the market power of the firms because it prevents some consumers from becoming knowledgeable about prices in the market in the model as competition increases firms tend to add more complexity to their prices as a best response rather than make their disclosures more transparent because this may substantially decrease consumer surplus in these markets such practices have important welfare implications

the market for quacks a group of n quacks plays a price competition game facing a continuum of patients who recover with probability whether or not they acquire a quack s treatment if patients chose rationally the market would be inactive i assume however that patients choose according to a boundedly rational procedure which re ects anecdotal reasoning this element of bounded rationality has signi cant

exchange rate overshooting the trade balance and rational expectations abstract this paper presents a model of exchange rate determination characterized by imperfect asset substitutability between domestic and foreign bonds sticky goods market prices and rational expectations the model is used to analyze the response of the exchange rate to a step change in relative money supplies the assumption of imperfect asset substitutability permits introduction into the analysis of trade flows which respond to relative price changes these flows create non monotonic exchange rate adjustments to long run equilibrium these non monotonic adjustments are consistent with rationality and may lead to short run undershooting or overshooting

do pharmacists buy bayer informed shoppers and the brand premium we estimate the effect of information and expertise on consumers willingness to pay for national brands in physically homogeneous product categories in a detailed case study of headache remedies we find that more informed or expert consumers are less likely to pay extra to buy national brands with pharmacists choosing them over store brands only 9 percent of the time compared to 26 percent of the time for the average consumer in a similar case study of pantry staples such as salt and sugar we show that chefs devote 12 percentage points less of their purchases to national brands than demographically similar nonchefs we extend our analysis to cover 50 retail health categories and 241 food and drink categories the results suggest that misinformation and related consumer mistakes explain a sizable share of the brand premium for health products and a much smaller share for most food and drink products we tie our estimates together using a stylized model of demand and pricing

focusing and framing of risky alternatives abstract this paper develops a theory of focusing and framing in an intertemporal context with risky choices we provide a selection criterion between existing theories of focusing by allowing a decision maker to choose her frame such that her attention is either drawn to salient events associated with an option or to the expected utilities an option yields in different time periods our key assumption is that a decision maker can choose her frame in a self serving manner we predict that the selected frame induces overoptimistic actions in the sense that subjects underrate downside risk but overrate upside risk and accordingly reveal overoptimistic choices hence our theory can explain phenomena such as excessive harmful consumption smoking unhealthy diet and risky investments entrepreneurship lotteries gambling in one coherent framework notably overoptimistic actions are not universal but have plausible limits we characterize under which situations overoptimistic actions are most likely to occur and under which circumstances choices should be rational or even pessimistic

price competition when three are few and four are many abstract i examine price competition in a market for a homogeneous good when consumers observe prices subject to a random shock perception error when firms have symmetric costs there exists a unique equilibrium in pure strategies which is symmetric when there are up to three sellers in the market the sellers extract the entire consumer surplus however with at least four firms assuming that the marginal cost is sufficiently low relative to consumers valuation both consumers and producers may enjoy a positive surplus the marginal cost pricing is never observed in an equilibrium with finitely many firms potential policy implications are discussed

tax arbitrage restrictions and financial leverage clienteles abstract this paper argues that while total short sale constraints are often introduced to rule out tax arbitrage such constraints are both unrealistic and conceptually problematic instead milder constraints are advocated which prevent tax arbitrage while still allow short positions it is demonstrated that a model with these constraints employed can support bond pricing as in the miller equilibrium although it leads to a richer set of tax clienteles

prominence complexity and pricing this paper analyzes prominence in a homogeneous product market where two firms simultaneously choose both prices and price complexity levels complexity limits competing offers comparability and results in consumer confusion confused consumers are more likely to buy from the prominent firm in equilibrium there is dispersion in both prices and price complexity the nature of equilibrium depends on prominence compared to its rival the prominent firm makes higher profit associates a smaller price range with lowest complexity puts lower probability on lowest complexity and sets a higher average price however higher prominence may benefit consumers and conditional on choosing lowest complexity the prominent firm s average price is lower which is consistent with confused consumers bias

price competition under limited comparability this paper studies market competition when firms can influence consumers ability to compare market alternatives through their choice of price formats we introduce random graphs as a tool for modelling limited comparability of formats our main results concern the interaction between firms equilibrium price and format decisions and its implications for industry profits and consumer switching rates we show that narrow regulatory interventions that aim to facilitate comparisons may have adverse consequences for consumer welfare finally we argue that our limited comparability approach provides a new perspective into the phenomenon of product differentiation

implied tax rates and the valuation of discount bonds abstract discount bonds afford the investor the opportunity for capital gains if for tax reasons the market is segmented on the demand side investors in lower and lower tax brackets must be attracted when interest rates rise and the supply of discount bonds increases changes in the differential tax on capital gains and interest income also should affect relative demand testing these hypotheses with u s treasury bond data the implied tax rate is found to vary over time in a manner consistent with market segmentation and tax law changes

modeling the economic interaction of agents with diverse abilities to recognize equilibrium patterns we model differences among agents in their ability to recognize temporal patterns of prices using the concept of debruijn sequences in two dynamic models of markets we demonstrate the existence of equilibria in which prices fluctuate in a pattern that is independent of the fundamentals and that can be recognized only by the more competent agents jel c7 d4 s477

examining the theory of capital structure signal factor hypothesis the aim of this study was to explore how various levels of information asymmetry affect the capital structure of listed companies in taiwan and china regression results over the past few decades have indicated that the trade off theory lacks explanatory power bringing into question the accuracy of the static trade off theory and the existence of an optimal capital structure on the other hand the financial decisions of companies do not always appear consistent with the pecking order theory building on the research of chou et al 2011 this study sought to verify the signal factor hypothesis which combines the trade off theory with the pecking order theory this study was the first one to employ the panel kpss test with sharp drifts developed by chang and ranjbar 2012 as well as the fourier function to verify that an optimal capital structure does exist for companies with more symmetric information thereby establishing the trade off theory firms with information asymmetry show adverse selection

a new linear programming approach to bond portfolio management a comment an analysis of the dual problem described by ronn 1987 reveals that it provides a powerful and easily interpretable test for the hypothesis of a single class of marginal investors including models of equilibrium based on a representative tax bracket when ronn s empirical tests are interpreted via the dual they lend additional support to his conclusions in providing a strong rejection of the representative tax bracket hypothesis a valid dual lp used to test the hypothesis can be obtained with fewer assumptions than ronn s primal in addition a minor error in ronn s presentation of the dual is corrected

speculative intensity and spot and futures price variability this paper develops a simultaneous stochastic rational expectations model of futures and spot price determination using the model we find that increases in what we term speculative intensity increase spot price variability arising from storage cost shocks but decrease spot price variability arising from demand shocks in contrast increases in speculative intensity unambiguously decrease futures price variability regardless of the underlying source of disturbances we are able to develop these comparative static results because the model has a unique equilibrium

term structure forecasts of inflation this paper investigates the information in the term structure of interest rates about future inflation using u k data the author finds that at horizons of up to four years the term structure has predictive value for inflation outcomes the term structure could thus provide a guide to the setting of monetary policy copyright 1992 by royal economic society

are negative option prices possible the callable u s treasury bond puzzle market prices for callable treasury bonds often imply negative values for the implicit call option the author considers a variety of possible explanations for these negative values including the treasury s track record in calling bonds optimally tax related effects tax timing options and bond liquidity none of these factors accounts for the negative values although the costs of short selling may explain why these apparent arbitrage opportunities persist over time why these implicit call values become negative in the first place remains a puzzle copyright 1992 by university of chicago press

tax induced bias in forward rates term premiums and the term structure of interest rates abstract this paper s analysis on the tax induced bias in forward rates enables us to better understand the structure of term premiums and the term structure of interest rates and to obtain a better estimate of the future interest rate in particular the anomaly of negative term premiums regarding long maturities as reported by fama 1984 is resolved

an international study of tax effects on government bonds it is shown that coupon bonds alone are not sufficient to span time dated claims on ordinary income capital gains and non taxable wealth in an incomplete bond market where the pure dated claims are not spanned by existing bonds marginal rates of substitution between present consumption and pure dated claims on ordinary income capital gains income and non taxable wealth respectively can differ across bondholders however the relative pricing of coupon bonds in each of these countries is shown to be consistent with the tax status of the major non tax exempt holders of government debt

tax effects in term structure estimation this study is a refinement and an extension of an earlier study by mcculloch of tax effects in the regression equation for term structure estimation this study includes tests for tax effects and heteroskedasticity a reconsideration of the need for an instrumental variable and a search for the capital gains tax rate in addition to the ordinary income tax rate there are two major findings 1 statistically significant taxinduced bias in the non tax adjusted equation and 2 evidence that the capital gains tax is misspecified in the tax adjusted equation it is well known e g see 4 2 pp 727 30 and 25 that the yield curve is an imperfect surrogate for the term structure of interest rates and various methods have been developed to estimate the term structure directly by regressing prices on payments in a sample of default free securities 1 since investors are concerned with the after tax payments on securities it is desirable to incorporate tax effects in term structure estimation mcculloch 22 and schaefer 26 29 have employed different approaches to the tax effect problem mcculloch employed the regression approach and searched for a single tax rate

term structure multiplicity and clientele in markets with transactions costs and taxes the authors investigate term structure with realistic transactions costs and taxes its properties are derived from a certain no arbitrage condition via duality theory in convex programming transactions costs imply an infinite multiplicity of term structures a simple example with realistic transactions costs shows that this multiplicity can induce a valuation range of over 277 basis points transactions costs also allow equilibrium without short sale restrictions the authors find the minimum transactions costs that prevent arbitrage in addition the exact conditions for weak clientele in which investors will not buy some bonds and may not sell any that they already hold are established most research on the pricing of riskless bonds hereafter bonds uses a noarbitrage model equilibrium pricing is based on the assumption that there is no buy and hold investment strategy that provides riskless arbitrage profit however most of these studies ignore transactions costs 2 the clientele model hereafter ss developed by stephen schaefer 19 adopts a no arbitrage assumption na equivalent to the existence of a valuation operator this operator is a vector of discount factors known as the term structure ss shows that na implies the existence of a tax bracket specific term structure that ensures that the bonds after tax present values do not exceed their prices ss also shows that in markets with spanning positive term structures consistent with na will not exist for some brackets see his example in subsection iva below investors in such brackets would have arbitrage opportunities to resolve this na violation and make equilibrium feasible ss assumes a prohibition on shorting this implies clientele effects in the usual sense i e investors in some brackets hold some but not all bonds there may be however a bracket in which investors hold positive amounts of all bonds this would be a

the relative pricing of u s treasury strips empirical evidence abstract we investigate pricing relations and the potential for arbitrage in the u s treasury strips market stressing the importance of reconciling quoted treasury data with actual market pricing conventions we document that stripping and reconstitution profits in the strips market are fleeting and rarely economically significant that matched maturity principal and coupon strips generally have different prices due at least in part to richness or cheapness in the underlying note or bond and that apparent negative forward rates in the strips market are concentrated in certain long maturity strips that do not actually exist at the time

real interest rates anticipated inflation and unanticipated money a multi country study a bstractin this paper we examine real interest rate behavior in canada west germany the united states and the united kingdom using a model that yields a semi reduced form equation linking the real interest rate to monetary growth shocks anticipated inflation and expected inflation variance the estimator used in our analysis accommodates regressors from other regressions ensuring that accurate inferences are obtained in all countries we find that increases in anticipated inflation initially dampen real interest rates in addition a significant and negative relationship between unanticipated money shocks and real interest across all countries is discovered inflation variance typically exhibits little explanatory power

price competition with consumer confusion this paper proposes a model in which identical sellers of a homogenous product compete in both prices and price frames i e ways to present price information we model price framing by assuming that firms frame choices affect the comparability of their price offers consumers may fail to compare prices due to frame differentiation and due to frame complexity in the symmetric equilibrium the firms randomize over both price frames and prices and make positive profits this result is consistent with the observed coexistence of price and price frame dispersion in the market we also show that i the nature of equilibrium depends on which source of consumer confusion dominates and ii an increase in the number of firms can increase industry profits and harm consumers

the effect of excessively elastic expectations on exchange rate volatility in the dornbusch overshooting model abstract bilson has described the empirical finding that the forward exchange rate overestimates the speed of return to equilibrium as a finding of excessive speculation and has drawn implications for the volatility of the exchange rate the present paper pursues this tack within the sticky price monetary model made famous by dornbusch it is shown theoretically that if the market overestimates the speed of adjustment the degree of overshooting is reduced in this sense excessive speculation leads to reduced volatility

testing term structure estimation methods evidence from the uk strips market prices and yields of uk government zero coupon bonds are used to test alternative yield curve estimation models zero coupon bonds permit a more pure comparison as the models are providing only the interpolation service and also not making estimation feasible it is found that better yield curves estimates are obtained by fitting to the yield curve directly rather than fitting first to the discount function a simple procedure to set the smoothness of the fitted curves is developed and a positive relationship between oversmoothness and the fitting error is identified a cubic spline function fitted directly to the yield curve provides the best overall balance of fitting error and smoothness both along the yield curve and within local maturity regions

term structure movements and pricing interest rate contingent claims this paper derives an arbitrage free interest rate movements model ar model this model takes the complete term structure as given and derives the subsequent stochastic movement of the term structure such that the movement is arbitrage free we then show that the ar model can be used to price interest rate contingent claims relative to the observed complete term structure of interest rates this paper also studies the behavior and the economics of the model our approach can be used to price a broad range of interest rate contingent claims including bond options and callable bonds

shrouded attributes consumer myopia and information suppression in competitive markets bayesian consumers infer that hidden add on prices e g the cost of ink for a printer are likely to be high prices if consumers are bayesian firms will not shroud information in equilibrium however shrouding may occur in an economy with some myopic or unaware consumers such shrouding creates an inefficiency which firms may have an incentive to eliminate by educating their competitors customers however if add ons have close substitutes a curse of debiasing arises and firms will not be able to profitably debias consumers by unshrouding add ons in equilibrium two kinds of exploitation coexist optimizing firms exploit myopic consumers through marketing schemes that shroud high priced add ons in turn sophisticated consumers exploit these marketing schemes it is not possible to profitably drive away the business of sophisticates it is also not possible to profitably lure either myopes or sophisticates to nonexploitative firms we show that informational shrouding flourishes even in highly competitive markets even in markets with costless advertising and even when the shrouding generates allocational inefficiencies

duopolistic competition with choice overloaded consumers a large body of experimental work has suggested the existence of a choice overload effect in consumer decision making faced with large menus of choice options decision makers often defer or avoid choice a suggested reason for the occurrence of this effect is that the agents attempt to avoid the cognitive effort that is associated with choosing from larger menus building on this explanation we propose and analyse a model of duopolistic competition where firms compete in menu design in the presence of a consumer population with heterogeneous preferences and overload menu size thresholds the firms strategic trade off is between offering a large menu in order to match the preferences of as many consumers as possible and offering a small menu in order to avoid losing choice overloaded consumers to their rival assuming uniformly distributed preferences we focus on symmetric pure strategy equilibria under various assumptions on the overload distribution and product markups we also propose and analyse a measure of consumer welfare that applies to this environment among other things we provide conditions for maximum and minimum variety equilibria to be possible whereby both firms either offer the entire set of available products or the same one product respectively

spot and forward rates in a stochastic model of the foreign exchange market abstract in this paper we develop a simultaneous stochastic model of spot and forward exchange rate determination under rational expectations for spot rates we find that increases in speculative responsiveness dampen the effects of trade balance shocks but exacerbate effects of interest rate shocks for forward rates though increases in speculative responsiveness dampen the effects of both trade balance and interest rate shocks the bias of the forward forecast error decreases as specualtive responsiveness increases but the expected squared error may increase

option pricing with differential interest rates the classic option pricing model is generalized to a more realistic imperfect dynamically incomplete capital market with different interest rates for borrowing and for lending and a return differential between long and short positions in stock it is found that in the absence of arbitrage opportunities the equilibrium price of any contingent claim must lie within an arbitrage band the boundaries of an arbitrage band are computed as solutions to a quasi linear partial differential equation and in generals each end point of such a band depends on both interest rates for borrowing and for lending this in turn implies that the vector of concurrent equilibrium prices of different contingent claims even claims that are written on different underlying assets must lie within a computable arbitrage oval in the price space article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

after tax term structures of real interest rates inferences from the uk linked and non linked gilt markets abstract this study estimates the after tax term structure of real interest rates using the prices of uk linked and non linked gilts over the period from 25 january 1986 until 25 october 1993 the impact of differential taxation and the existence of noise in observed market prices is found to produce a significant impact on the parameter estimation of term structure models when compared to methods such as brown and schaefer brown r schaefer s 1994 journal of financial economics 35 1 42 that did not two major observations can be made regarding the estimates for spot real interest rates firstly the volatility of the short term rate is much lower than that found by brown and schaefer 1994 which provides a better fit with the predictions of the cir single factor model for interest rates secondly consistent with rumsey rumsey j 1993 an impact of the assumptions about taxes on the estimation of the properties of interest rates working paper there appears to be some evidence to suggest that single factor interest rate models produce a better fit to interest rates on an after tax basis than on a before tax basis

a comparison of yield curve estimation techniques using uk data abstract i compare different methods of estimating the term structure of interest rates on a daily uk treasury bill and gilt data that spans the period from january 1995 to january 1999 in sample and out of sample statistics reveal the superior pricing ability of certain methods characterised by an exponential functional form in addition to these standard goodness of fit statistics model performance is judged in terms of two trading strategies based on model residuals both strategies reveal that parsimonious representations of the term structure perform better than their spline counterparts characterised by a linear functional form this is valid even when abnormal returns are adjusted for market movements linear splines overfit the data and are likely to give misleading results

debt agency costs and industry equilibrium we show that risk characteristics of projects cash flows are endogenously determined by the investment decisions of all firms in an industry as a result in reasonable settings financial structures which create incentives to expropriate debtholders by increasing risk are shown not to reduce value in an industry equilibrium without taxes capital structure is irrelevant for individual firms despite its effect on the equityholders incentives but the maximum total amount of debt in the industry is determinate allowing for a corporate tax advantage of debt capital structure becomes relevant but firms are indifferent between distinct alternative debt levels the effect of firms financial structures on subsequent investment and output decisions has recently received considerable attention in the finance literature the central insight that equityholders control the firm s investment and production decisions and in general do not maximize the value of a levered firm has been applied to the analysis of risk shifting underinvestment and firms abilities to enter into optimal contracts with their customers existing models of firms financial structures and their effect on investment decisions are generally based on a single firm framework and do not take into account the relationship between project cash flows and the investment decisions of all firms in the industry 2 in this paper we allow the distribution of investment projects within an industry to adjust and show that this generates new insights and reverses several key results of single firm agency cost models the new predictions conform with well documented

tax induced clientele effects in the market for british government securities abstract this paper develops a new methods for measuring tax effects in bond markets and presents empirical results for british government securities the basic idea is to construct a least cost portfolio which for investors in a given tax bracket dominates a given bond a portfolio is said to dominate a bond if it provides cash flows which are at least as great in every period and has a lower price in effect our method calculates an upper bound on the value of a bond to investors in a given tax bracket the results demonstrate i the existence of clientele effects and ii the absence of an effective tax rate

models of the yield curve and the curvature of the implied forward rate function abstract we examine several alternative models of the uk gilt yield curve using daily data for the period 12 july 1996 10 february 2010 we select the best models according to two criteria low out of sample errors in pricing bonds and low curvature of the implied forward rate curve function we suggest additions to some of the models that significantly improve their performance some of the new models out perform those typically used by the central banks in particular this paper suggests that the model used by the canadian central bank which both outperforms other models and is particularly easy to estimate is well suited to the uk gilt market

the effect of forward exchange on spot rate volatility under risk and rational expectations abstract this paper presents a multiperiod rational expectations model of a foreign exchange market in order to analyze the effect of introducing currency forward trading on measures of exchange rate volatility based on an optimizing approach to risk average agents it highlights how commercial traders and interest arbitrageurs behave facing exchange risk and forward contracting opportunities it is found that forward trading tends to stabilize spot exchange rates if the trade disturbance is the predominant random factor in the market while it exacerbates spot rate variability if the disturbance in the interest rate differential is the chief stochastic element

price competition with satisficing consumers abstract the satisficing heuristic by simon 1955 has recently attracted attention both theoretically and experimentally in this paper i study a price competition model in which the consumer is satisficing and firms can influence his aspiration price via marketing unlike existing models whether a price comparison is made depends on both pricing and marketing strategies i fully characterize the unique symmetric equilibrium by investigating the implications of satisficing on various aspects of market competition the proposed model can help explain well documented economic phenomena such as the positive correlation between marketing and prices observed in some markets

municipal debt and marginal tax rates is there a tax premium in asset prices we study the marginal tax rate incorporated into short term municipal rates using municipal swap market data using an affine model we identify the marginal tax rate and the credit liquidity spread in 1 week tax exempt rates as well as their associated risk premia the marginal tax rate averages 38 0 and is related to stock bond and commodity returns the tax risk premium is negative consistent with the strong countercyclical nature of after tax fixed income cash flows these results demonstrate that tax risk is a systematic asset pricing factor and help resolve the muni bond puzzle

miller s equilibrium shareholder leverage clienteles and optimal capital structure the purpose of this paper is twofold first we examine the individual portfolio decisions when income from stocks and bonds is taxed at different rates second a rationale for the existence of risky debt in the presence of leverage related costs and differential personal income taxation is provided previous studies on capital structure with differential personal income taxation have ignored either the portfolio risk consideration and or the possibility of losing personal and corporate interest tax shields due to insufficient taxable earnings e g 8 2 3 14 13 6 7 1 9 19 20 21 23 in section i of this paper both the portfolio risk consideration and the possibility of losing personal and corporate interest tax shields are explicitly introduced this enables us to provide a rationale for the shareholder leverage clientele phenomenon within a mean variance framework we also demonstrate a non corner solution for the optimal corporate capital structure in a tax environment similar to that of miller s debt and taxes 14 in sections ii and iii of this paper miller s world is further modified to include risky debt and the attendant costs we re examine and synthesize recent studies on the theory of optimal capital structure which have appeared since the publication of debt and taxes e g 4 6 7 13 19 20

beyond revealed preference choice theoretic foundations for behavioral welfare economics we propose a broad generalization of standard choice theoretic welfare economics that encompasses a wide variety of nonstandard behavioral models our approach exploits the coherent aspects of choice that those positive models typically attempt to capture it replaces the standard revealed preference relation with an unambiguous choice relation roughly x is strictly unambiguously chosen over y written xp y iff y is never chosen when x is available under weak assumptions p is acyclic and therefore suitable for welfare analysis it is also the most discerning welfare criterion that never overrules choice the resulting framework generates natural counterparts for the standard tools of applied welfare economics and is easily applied in the context of specific behavioral theories with novel implications though not universally discerning it lends itself to principled refinements

inferior products and profitable deception we analyse conditions facilitating profitable deception in a simple model of a competitive retail market firms selling homogenous products set anticipated prices that consumers understand and additional prices that naive consumers ignore unless revealed to them by a firm where we assume that there is a binding floor on the anticipated prices our main results establish that bad products those with lower social surplus than an alternative tend to be more reliably profitable than good products specifically 1 in a market with a single socially valuable product and sufficiently many firms a deceptive equilibrium in which firms hide additional prices does not exist and firms make zero profits but perversely 2 if the product is socially wasteful then a profitable deceptive equilibrium always exists furthermore 3 in a market with multiple products since a superior product both diverts sophisticated consumers and renders an inferior product socially wasteful in comparison it guarantees that firms can profitably sell the inferior product by deceiving consumers we apply our framework to the mutual fund and credit card markets arguing that it explains a number of empirical findings regarding these industries

a more general model of price complexity this paper considers a model of competition in prices and price complexity levels which accommodates concave and convex confusion technologies in symmetric equilibrium the probability of using high complexity increases in the number of firms in the limit as the number of competitors goes to infinity firms use high complexity almost surely but the impact on consumer welfare depends on the characteristics of the confusion technology specifically industry profits converge to the highest level with concave confusion technologies and to the lowest level when with convex confusion technologies an improvement in consumer sophistication increases consumer welfare but does not reduce market complexity

the effects of regulating hidden add on costs we examine the welfare effects of price and disclosure regulation in a model where firms can shroud add on costs such as penalty fees for consumer financial products such regulation can increase or decrease welfare even when there are no direct costs there are however strong complementarities between price controls and disclosure mandates conditional on disclosure being mandated price controls always weakly increase welfare and conditional on prices being sufficiently constrained disclosure mandates always weakly increase welfare

tax arbitrage and the existence of equilibrium prices for financial assets in models where both investors and securities are subject to differential taxation there may be no set of prices that rule out infinite gains to trade or tax arbitrage this paper characterizes the joint restrictions on financial asset returns and investors tax schedules that preclude tax arbitrage in the absence of short sale constraints the authors show that if there exists any configuration of marginal tax rates on investors tax schedules that rule out infinite gains to trade then no tax arbitrage prices will exist they also show that the existence of no tax arbitrage prices ensures the existence of equilibrium prices the effects of differential taxation on the equilibrium prices of financial assets have attracted much attention from financial economists in recent years otherwise identical securities that contribute to taxable income to different degrees will in general be valued differently by taxable investors as a result tax considerations have been useful in helping explain the effect of dividend yield on stock returns the effect of coupon levels and term to maturity on bond prices 2 the timing of investors portfolio transactions 3 and the observed capital structures of firms 4 while a rich set of observed behaviors can be better understood by reference to differential taxation there are well known difflculties in dealing with taxes in a general equilibrium setting to clear markets relative prices must reflect the marginal rates of substitution of all agents simultaneously when tax rates differ across investors however this condition can be impossible to achieve to illustrate consider a world of perfect certainty with two assets a tax exempt municipal bond and a taxable government bond to equate marginal rates of substitution the rate of return on the government bond rg must equal that on the municipal rm grossed up by one minus the investor s marginal tax rate ti that is rg rm 1 ti if there are investors in more than one tax bracket this condition will obviously be impossible to satisfy for all of them simultaneously both authors from graduate school of industrial administration carnegie mellon university we wish to thank scott richard steven spear and an anonymous referee for helping us sort through the issues considered here seminar participants at columbia wharton the johnson symposium on asset pricing at the university of wisconsin madison and the 1986 western finance association meeting also provided valuable comments we are also grateful for the financial support provided by the center for public policy research carnegie mellon university all errors are our own responsibility

the value of the tax subsidy on risky debt the effect of corporate taxes on the market value of a levered firm continues to be a central issue in recent contributions in finance theory e g miller 1977 deangelo and masulis 1980 kim 1982 modigliani 1982 in these and other studies e g krause and litzenberger 1973 scott 1976 brennan and schwartz 1978 kim 1978 the relationship between market value and capital structure is established by formulating a tax subsidy function that specifies the partial effect of debt on the expected tax savings at the corporate level under the existing u s tax code a working assumption in most of these studies is that both principal and interest are tax deductible this assumption is made in the spirit of the original modigliani and miller 1963 formulation in which debt is taken to be perpetual and riskless indeed it is well known that the tax shield provided by the deduction of principal in a singleperiod framework has the same value as the tax shield from interest deductions in the case of perpetual and riskless debt under this assumption it is shown that in the absence of non debtthis paper examines the relationship between leverage and the value of the firm when non debt related tax shields are available and the corporate tax is levied as an income tax in a previous paper de angelo and masulis argue that in the presence of nondebt related tax shields the relationship between debt and firm value is concave resulting in an interior optimal capital structure when there is a tax induced differential in the cost of corporate debt their result derives from the fact that they assume the payment of debt principal and non debt related depreciation charges are deductible however the former deduction is consistent with a wealth tax while the latter is consistent only with an income tax we show that if the interest alone is deductible the debt firm value function is convex resulting in corner solutions to the capital structure problem the authors wish to thank richard castanias richard green lemma senbet and especially an anonymous referee for helpful comments and richard green and robert dammon for computational assistance

a multicountry comparison of term structure forecasts at long horizons abstract this paper extends previous work on the information in the u s term structure at longer maturities to britain west germany and switzerland we find strong evidence that the term structure does have significant ability to forecast changes in inflation particularly at long maturities on the other hand the ability of the term structure to forecast changes in one year interest rates is somewhat weaker only at the very longest horizon five years is there significant forecasting ability for interest rate changes

bond pricing in markets with taxes abstract two types of equilibrium models in bond markets with taxes exist the clientele model by schaefer and the litzenberger rolfo s model this paper reviews the two models in two frameworks utility arguments and no arbitrage arguments both show that schaefer s is more realistic

collusion with intertemporal price dispersion we develop a theory of optimal collusive intertemporal price dispersion dispersion clouds consumer price awareness encouraging firms to coordinate on dispersed prices our theory generates a collusive rationale for price cycles and sales patient firms can support optimal collusion at the monopoly price for less patient firms monopoly prices must be punctuated with fleeting sales the most robust structure involves price cycles that resemble edgeworth cycles low consumer attentiveness enhances the effectiveness of price dispersion by reducing the payoff to deviations involving price reductions however for sufficiently low attentiveness price rises are also a concern

an equilibrium analysis of debt financing under costly tax arbitrage and agency problems in his recent paper merton miller 12 extends the notion of tax induced differential returns on securities into a general equilibrium framework in which firms make adjustments in the supply of corporate debt in an environment of progressive personal taxation the interest rates on taxable corporate bonds are greater than rates on tax exempt securities so as to compensate investors for the associated tax burden on the supply side value maximizing firms have an incentive to issue additional debt so long as the personal tax induced compensation is less than the tax savings from interest payment deductions at the corporate level miller argues that in the final equilibrium the interest rate differential between taxable and tax exempt bonds exactly reflects the tax advantage of debt financing at the corporate level thus the tax subsidy disappears in its entirety and we are back to an environment in which corporate leverage is inconsequential to the value of any particular firm what emerges in equilibrium is merely an optimal debt equity ratio for the corporate sector as a whole 1 miller derives this invariance proposition under the following assumptions 1 progressive personal tax rates reach a maximum at a level beyond the corporate tax rate 2 no tax arbitrage by individuals and firms is allowed 3 there is a personal tax rate differential in favor of income from stocks and 4 the opportunity for riskless borrowing and lending exists 2 indeed miller s equilibrium analysis is based on a zero effective personal tax rate on income from stocks but

taxation portfolio choice and debt equity ratios a general equilibrium model this paper explores the portfolio behavior of investors differing with respect to both tax rates and risk aversion emphasizing the role of constraints on individual and firm behavior in ensuring the existence of and characterizing portfolio equilibrium under certain conditions on the securities available in the market which also are necessary for shareholders to be unanimous in supporting firm value maximization investors will be segmented by tax rate into two groups one specialized in equity and the other in debt though the relative wealths of the two groups determine the aggregate debt equity ratio each firm will be indifferent to its financial policy

helping consumers know themselves in standard models with asymmetric information the parties involved are assumed to have private information about their own characteristics in the health insurance market for example customers are typically assumed to know more about their health status than insurers do and if the customers use this information in deciding whether to buy insurance we have a classic case of adverse selection modern data gathering technologies however can reverse this situation for example because cell phone providers keep and analyze detailed records they can know more about a consumer s expected usage than the customer herself does similarly a credit card company may know more about a customer s probability of incurring a late fee than the customer herself we explore the consequences of this reversal in the information asymmetry 1 a bare bones model examines how providing consumers with information about their own usage affects prices and welfare we first establish the rather obvious result that taking prices as given consumers benefit from having better information about their own usage they can choose the pricing plans that are more suitable for them recent

bond returns liquidity and missing data this paper examines holding period returns to constant duration portfolios of u s govern ment notes and bonds and measures the return premium generated by liquidity differences in bonds the approach compares constant duration portfolios constructed in two distinct ways one using only bonds issued in the most recent treasury auction one using all other bonds comparisons of the resulting series are made meaningful by choosing narrow du ration ranges in the portfolio formation procedure this in turn induces a missing data problem in the created time series parameters of return distributions are therefore estimated employing a maximum likelihood framework that explicitly accounts for the missing data it is estimated that recently issued bonds are priced to return a premium of around 55 basis points per annum over otherwise equivalent instruments

international capital markets and foreign exchange risk author s brennan michael j xia yihong abstract the relation between the volatilities of pricing kernels associated with di erent currencies and the volatility of the exchange rate between the currencies is derived under the assumption of integrated capital markets and the volatilities of the pricing kernels are related to the foreign exchange risk premium time series of pricing kernel volatilities are estimated from panel data on bond yields for five major currencies using a parsimonious term structure model that allows for time varying pricing kernel volatilities the resulting estimates are used to test hypotheses about the relation between the volatilities of the pricing kernels in di erent currencies and the volatility of the exchange rate as predicted time variation in foreign exchange risk premia is found to be related to time variation in both the volatility of the pricing kernels and the volatility of exchange rates the estimated pricing kernel volatilities can account for the forward premium puzzle in an average sense across exchange rates

price complexity and buyer confusion in markets abstract this paper reports a duopoly market experiment that examines the effects of price complexity on market prices in my experimental posted offer markets each seller offers an identical good to buyers with homogeneous preferences first sellers simultaneously decide on the price and the tariff structure of their good then buyers make their choices each seller can choose to have a one two or three part tariff the tariff structure affects neither the value nor the price of the good but influences buyers ability to calculate the good s price the main results show that high price sellers choose high complexity more often than low price sellers if buyers are simulated in accordance with the bounded rationality model of carlin 2009 however the evidence for this effect is weaker if the buyers are human subjects importantly prices are higher when the sellers can confuse buyers using price complexity than when sellers interact with perfectly rational robot buyers

the critical implicit tax rate and capital structure in a miller world firms are indifferent between debt and equity when the tax rate that isimplicitly used to price a bond is equal to the statutory corporate tax rate in this paper we derive the implicit tax rate that makes a firm marginally indifferent between debt and equity when debt related tax savings are uncertain we analyze the functional relationship between this critical tax rate and the amount of debt issued by a firm and discuss the implications for a firm s optimal capital structure

catering to investors through security design headline rate and complexity this study investigates how banks design financial products to cater to yield seeking investors we focus on a large market of investment products targeted exclusively at households retail structured products these products typically offer a high return under their best case scenario the headline rate that is nested in a complex payoff formula using a text analysis of the payoff formulas of the 55 000 products issued in europe from 2002 to 2010 we measure product headline rates complexity and risk over this period product headline rates depart from the prevailing interest rates as the latter decrease complexity increases and risky products become more common in the cross section the headline rate of a product is positively correlated with its level of complexity and risk higher headline rate more complex and riskier products appear more profitable to the banks distributing them our results suggest that financial complexity is a by product of banks catering to yield seeking investors

taxes capital structure and bondholder clienteles despite much recent progress financial theory has yet to explain the connection if any between the u s tax code and many observed characteristics of corporate bonds empirically why is there no single tax rate equating yields on corporate bonds with yields on tax exempt municipal bonds of apparently identical risks and maturities 2 specifically why does the spread in yields between corporate and municipal bonds divided by the yield on corporates a conventional measure of the marginal tax rate on corporates decrease with increasing risk and maturity more generally why are different types of bonds evidently held by clienteles of investors in tax clienteles for corporate bonds are identified in a competitive financial equilibrium under an asymmetric corporate income tax with interest preceding principal state contingent bonds with higher coupon yields are issued by firms with higher pretax cash inflows per dollar of nondebt tax shield purchased by investors in lower tax brackets and implicitly priced at lower marginal tax rates on these bonds all investors earn tax induced surpluses by contrast all other bonds have implicit tax rates typically equal to the corporate rate and yield for many investors no tax induced surpluses we gratefully acknowledge the helpful comments of george constantinides kose john merton miller jim scott marti subrahmanyam and participants in seminars at baruch chicago columbia houston michigan nyu rutgers usc washington wharton the american finance association the western finance association and the johnson symposium on taxes and finance at wisconsin george constantinides was especially helpful 1 the most notable contribution is miller 1977 other recent papers include chen and kim 1979 kim lewellen and mcconnell 1979 deangelo and masulis 1980a 1980b taggart 1980 kim 1982 auerbach and king 1983 and talmor haugen and bornea 1985 black 1971 anticipates an equilibrium with clienteles 2 schaefer 1982a identifies tax induced clienteles of bondholders in the british gilt market van horne 1982 reports that implicit tax rates vary over time as the supply of discount bonds changes additional evidence is cited in trczinka 1982

the decline in idiosyncratic values of us treasury securities abstract unique features and market frictions can lead to idiosyncratic pricing for some us treasury securities this study uses a linear programming lp model to measure aggregate idiosyncratic pricing of t notes and t bonds from 1980 to 2016 we document an average idiosyncratic pricing of 0 11 per 100 par as compared to an average bid ask spread of 0 08 further idiosyncratic pricing declined dramatically from the early 1980s to the 2010s empirical evidence suggests that the 1986 tax reform act increasing issue sizes and improving market liquidity contribute to the decline at the individual security level we identify factors contributing to and mitigating idiosyncratic pricing

a new linear programming approach to bond portfolio management this paper derives and tests a new linear programming lp approach to bond portfolio management the model elicits possible tax clientele effects in the pricing of u s gov ernment coupon bonds and simultaneously derives the optimal tax specific bond portfolio analytically the model derives these results by exploiting for a given tax bracket the price differential of an after tax stream of cash flows it accomplishes this objective by purchasing at the ask price underprieed bonds for the specific tax bracket while sim ultaneously selling at the bid price overpriced bonds the model requires that the net cash flow inclusive of purchased and sold bonds be nonnegative at all future dates the problem s formulation standardizes the position taken in each bond to a maximum of one unit one of the model s appealing features is the parsimonious number of required calcu lations only one lp program need be run per tax bracket in addition to obtaining an optimally chosen tax specific bond portfolio the model also measures the after tax term structure of spot u s government interest rates for both tax exempt and taxable investors finally the superior monthly holding period rates of return on the optimal taxspecific bond portfolio demonstrate an important property ofthe model s output

consideration sets and competitive marketing we present a model of competitive marketing based on the notion that consumers are boundedly rational and that firms use marketing tactics in an attempt to influence consumers decision process the standard model of consumer behaviour assumes that the consumer applies well defined preferences to a perfectly perceived set of available alternatives we retain the assumption that consumers have stable preferences but relax the assumption that they have a perfect perception of what is relevant for their consumption problem thus allowing firms to manipulate that perception our aim is to explore the market implications of this departure from the standard model especially for the way firms deploy marketing strategies in competitive environments the cornerstone of our model is the observation that in the modern marketplace consumers face an overwhelmingly large variety of products and therefore often use screening criteria deliberate as well as unconscious in order to reduce the number of relevant alternatives as a result consumers apply their preferences not to the set of objectively feasible alternatives but to a potentially smaller set which they construct at an earlier stage of the decision process borrowing a term from the marketing literature we refer to this set as the consideration set the basic idea underlying this term is that consumers may be unaware of some of the feasible products and even when they become aware of a new product they still need to be persuaded to consider it as a potential substitute to their currently consumed product

diagnosing consumer confusion and sub optimal shopping effort theory and mortgage market evidence mortgage loans are leading examples of transactions where experts on one side of the market take advantage of consumers lack of knowledge and experience we study the compensation that borrowers pay to mortgage brokers for assistance from application to closing two findings support the conclusion that confused borrowers overpay for brokers services i a model of effective shopping shows that bor rowers sacrifice at least 1 000 by shopping from too few brokers ii borrowers who compensate their brokers with both cash and a commission from the lender pay twice as much as similar borrowers who pay no cash jel d12 d14 g21 we study a large and financially complex expenditure that the majority of consumers make only a few times in their lives the payment for mortgage origination services in these transactions information is not only imperfect but traditional market practices have likely contributed to consumer confusion these payments range from 0 to 30 000 for mortgages of normal size mortgage brokers receive payments from both borrowers and from wholesale lenders on most loans broker fees paid in cash by the borrower are usually broken down into more than a dozen individual items such as origination fee discount points funding fee and doc prep in addition to these cash payments about half of the value that the bor rower transfers to the broker takes the form of a payment from the wholesale lender to the mortgage broker the borrower bears the burden of this part of the payment in the form of a higher interest rate on the loan these payments compensate mortgage brokers for arranging mortgage loans we stress that this paper is about how and how much borrowers pay their brokers for origination services the broker is an administrator of the process of loan origination the broker bears none of the risk of default on the mortgage so that risk is not a determinant of the broker s compensation under standard theories of pricing because consumers enter the mortgage market infrequently and because features of the market make it difficult to learn the best price mortgage origination pricing

special repo rates an empirical analysis duffie 1996 examines the theoretical impact of repo specials on the prices of treasury securities and concludes that all else the same an issue on special will carry a higher price than an otherwise identical issue we examine this hypothesis and find strong evidence in support of it we also examine whether the liquidity premium associated with on the run issues is due to repo specialness and find evidence of a distinct effect finally we investigate whether auction tightness and percentage awarded to dealers are related to subsequent specialness and find that both variables are generally significant underlying the cash market for u s treasury securities is the financing or repo market at any given time the repo rate for most treasury issues the general collateral rate is the same but a few issues are typically on special an issue on special has associated with it a repo rate that is less than the prevailing general collateral rate as a result the owner of a security that is on special is able to obtain below market financing rates via a repurchase agreement duffie 1996 examines the theoretical causes of repo specials and their impact on the prices of treasury securities in the context of a general equilibrium model his primary conclusion is that specialness will be priced in the cash market meaning that all else the same an issue on special or likely to go on special will carry a higher price than an otherwise identical issue we investigate this hypothesis using data on repo specials and find clear evidence in support of it we conclude that specialness is priced and that the magnitude of the cash market premium reflects both the future duration and magnitude of repo specialness we also examine whether the liquidity premium associated with on therun issues is due to repo specialness and find evidence of a distinct effect finally as a test of duffie s model we investigate whether auction tightness and percentage awarded to nonbank primary dealers are related to subsequent specialness the evidence is consistent with predictions with both variables generally significant

pricing contingent claims under interest rate and asset price risk this paper presents a general framework for pricing contingent claims under interest rate and asset price uncertainty the framework extends ho and lee s 1986 valuation framework by allowing not only future interest rates but also future asset prices to depend on the current term structure of interest rates the approach is shown to provide risk neutral valuation relationships that are consistent with the initial term structure of interest rates and can be applied to valuation of a broad class of assets including stock options convertible bonds and junk bonds

lease valuation when taxable earnings are a scarce resource in this paper we examine leasing as a tax arbitrage instrument analysis of a sample of uk leases presented in this paper suggests that lessors earn large positive npvs our theoretical model seeks to explain these positive npvs in terms of a market price for a scarce resource that we identify as scarce taxable earnings using these prices the model permits a lessor to determine whether the profitability of a proposed set of lease contracts can be improved by writing e different set of contracts that makes better use of the lessor s taxable earnings there may be two reasons why an initial portfolio of contracts may be suboptimal either there may be clienteles or the leasing market may be inefficient subsequently we discuss reasons why the leasing market may be characterized by clienteles and using two different samples of leases we test whether the leasing market is segmented and efficient in this paper we examine leasing as a tax arbitrage instrument with asymmetrical tax positions between lessors and lessees there will be positive net present values npvs to lease transactions see myers dill and bautista 21 analysis of a sample of united kingdom uk leases presented in this paper suggests that lessors earn large positive npvs our theoretical model seeks to explain these positive npvs in terms of a market price for a scarce resource that we identify as scarce taxable earnings there are two implications of our model one for financial intermediaries that act as lessors and the other for financial economists interested in the leasing market the model permits a lessor to determine whether the profitability of a proposed set of lease contracts can be improved upon by writing a different set of contracts that makes better use of the lessor s taxable earnings there may be two reasons why an initial portfolio of contracts that a lessor is about to write may be suboptimal either there may be clienteles because the leasing market

on the existence of pure and mixed strategy nash equilibria in discontinuous games a game is better reply secure if for every nonequilibrium strategy x and every payoff vector limit u resulting from strategies approaching x some player i has a strategy yielding a payoff strictly above u i even if the others deviate slightly from x if strategy spaces are compact and convex payoffs are quasiconcave in the owner s strategy and the game is better reply secure then a pure strategy nash equilibrium exists better reply security holds in many economic games it also permits new results on the existence of symmetric and mixed strategy nash equilibria

arbitrage pricing transaction costs and taxation of capital gains abstract this paper examines one of the few cases of seemingly redundant securities sets of three government bonds with the same maturity date within the bounds on relative bond prices established by tax exempt investors in a market with proportional transaction costs the taxation of capital gains on the basis of realization has a significant impact on relative prices the empirical evidence supports the tax option effect discussed by constantinides and ingersoll but does not generally support the segmented tax clientele equilibrium discussed by schaefer

immunization as a maxmin strategy the purpose of this paper is to broaden the analysis of immunization when it is viewed as amaxmin strategy several results are demonstrated which provide a new interpretation of maxmin strategy by using a more general theory of lagrangians we clarify the exact assumptions required for the duration strategy and the maxmin strategy to be equivalent in a world with taxes it is shown that in a world with taxes the immunization strategy requires the portfolio to satisfy a constraint about the bond to be included in addition to the duration constraint

putting on a tight leash and levelling playing field an experiment in strategic obfuscation and consumer protection the paper reports the results of an experiment where asymmetric sellers of a product can obfuscate the market we show that policy measures may have unintended effects of increasing obfuscation incentives we find that policies that limit the effectiveness of obfuscation and policies that promote parity between firms can lead less prominent firms to increase their obfuscation efforts despite this unintended effect however the former type of policies is effective in boosting consumer welfare

tax clienteles and optimal capital structure under uncertainty this article demonstrates that investors heterogeneous tax status implies that they value bonds differently at the margin due to asymmetric personal taxes high risk bonds generate a higher amount of taxable income than low risk bonds and are therefore held by investors in low tax brackets in such a setting firms can increase their value by choosing a capital structure that attracts a particular bondholder clientele the author analyzes how bondholder clienteles change as the uncertainty about a bond s final payoff is resolved over time and shows how tax clientele effects influence firms capital structure decisions copyright 1990 by the university of chicago

on price recognition and computational complexity in a monopolistic model a single seller of an indivisible good operates in a market with many consumers who differ in their ability to process information the consumers constraints are modeled in two submodels the first in terms of the limits on the number of sets in the partition of the price space and the second in terms of the limits on the complexity of the operation he can use to process a price offer for the construction of the second submodel the tool of a perceptron is borrowed from the parallel computation literature assuming a negative correlation between the seller s cost of supply of the good and the consumer s ability to process information i demonstrate that the heterogeneity of consumer s abilities can be used by the seller to profitably discriminate among them