How Much of the Corporate Bond Spread in Due to Personal Taxes

Publication Type

Journal Article

Publication Date

2007

Abstract

Existing term structure models of defaultable bonds have often underestimated corporate bond spreads. A potential problem is that investors’ taxes are ignored in these models. We propose a pricing model that accounts for stochastic default probability and differential tax treatments for discount and premium bonds. By estimating parameters directly from bond data, we obtain significantly positive estimates for the income tax rate of a marginal corporate bond investor after 1986. This contrasts sharply with the previous finding that the implied tax rates for Treasury bonds are close to zero. Results show that taxes explain a substantial portion of corporate bond spreads

Keywords

Existing term structure models of defaultable bonds have often underestimated corporate bond spreads. A potential problem is that investors’ taxes are ignored in these models. We propose a pricing model that accounts for stochastic default probability and differential tax treatments for discount and premium bonds. By estimating parameters directly from bond data, we obtain significantly positive estimates for the income tax rate of a marginal corporate bond investor after 1986. This contrasts sharply with the previous finding that the implied tax rates for Treasury bonds are close to zero. Results show that taxes explain a substantial portion of corporate bond spreads

Discipline

Finance and Financial Management | Portfolio and Security Analysis

Research Areas

Finance

Publication

Journal of Financial Economics

Volume

85

Issue

3

First Page

599

Last Page

636

ISSN

0304-405X

Identifier

10.1016/j.jfineco.2006.08.002

Publisher

Elsevier

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