Publication Type

Journal Article

Publication Date

1-2003

Abstract

Empirical studies have documented the dependence of corporate credit spreads on default risk, equity premiums, and taxes. However, taxes have previously not been incorporated into reduced-form credit risk models. Therefore, we first extend the existing literature by considering a default intensity that depends on taxes as well as the default-free short rate and a market index. Consequently, we establish a theoretical basis to explain previous empirical findings regarding the significant impact of taxation on defaultable bond prices. Unlike previous models, tax implications for defaultable debt cannot be constructed from a sum of tax effects on zero coupon bonds. Our empirical tests then illustrate the importance of taxation. In particular, the impact of taxation increases as a function of the debt's maturity and coupon rate.

Discipline

Corporate Finance | Finance and Financial Management | Portfolio and Security Analysis

Research Areas

Finance

Publication

Journal of Risk Research

Volume

6

Issue

2

First Page

1

Last Page

29

ISSN

1465-1211

Publisher

Incisive Financial Publishing