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

• Main Authors: WU, Chunchi, Liu, Sheen, Shi, J., Wang, Junbo
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2007
• Subjects: 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; Finance and Financial Management; Portfolio and Security Analysis
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/782; https://doi.org/10.1016/j.jfineco.2006.08.002
• Institution: Singapore Management University

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