JOURNAL ARTICLE
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On Black, Blue and Orange Bonds
A Tax Arbitrage Model with Asymmetric Taxation
Credit and Capital Markets – Kredit und Kapital, Vol. 28 (1995), Iss. 2 : pp. 270–297
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Johannes Raaballe, Aarhus
References
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Robert M. Dammon and Richard C. Green. Tax Arbitrage and the Existence of Equilibrium Prices for Financial assets. The Journal of Finance, December 1987.
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Jaime Cuevas Dermody and Eliezer Zeev Prisman. Term Structure Multiplicity and Clientele in Markets with Transactions Cost and Taxes. The Journal of Finance, September 1988.
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Jaime Cuevas Dermody and R. Tyrell Rockafellar. Cash Stream Valuation in the Face of Transaction Costs and Taxes. Mathematical Finance, January 1991.
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Abstract
This paper considers a one-period economy with both private and corporate investors. The market under consideration consists of three types of bonds (called black, blue and orange), which in one way or another differs with respect to taxation. It is shown that the absence of infinite tax arbitrage opportunities implies that all private investors will end up with the same marginal tax rate. This tax rate is no larger than the smallest corporate marginal tax rate. At the same time all types of bonds except claims selling at par exhibit clienteles. In the literature on bond arbitrage the clienteles are created by means of transaction costs or a (partial) ban on issuing bonds. The exhibition of clienteles in this model hinges on asymmetric taxation. Concluding the paper is a discussion of the effect of introducing previously issued blue bonds into the analysis.