Article1988

Was the Tax-Exempt Bond Market Inefficient or Were Future Expected Tax Rates Negative?

46 citations0/0 files storedThe Journal of Finance

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Financial Markets and Investment Strategies Stochastic processes and financial applications Credit Risk and Financial Regulations

Abstract

ABSTRACT This paper shows that the sharp narrowing with maturity of the spread between taxable and tax‐exempt yields leaves room for tax arbitrage. At times, tax‐exempt forward rates have exceeded taxable forward rates. At such times, only expectations of higher taxes on Treasury than on municipal bonds would eliminate profit opportunities. The authors develop the idea of forward tax rates and compute forward tax rates for 1955 through 1984. They also outline tax‐arbitrage mechanisms involving private forward sale of long municipal bonds or the use of the Municipal Bond Futures Contract and show the potential profits.

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References

1977DEBT AND TAXES*1982Dividends and Taxes: Some Empirical Evidence 1983Taxation, Portfolio Choice, and Debt-Equity Ratios: A General Equilibrium Model 1982The Pricing of Tax-Exempt Bonds and the Miller Hypothesis 1989Tax Reform and the Market For Tax-Exempt Debt 1985Taxes, Default Risk, and Yield Spreads 1986Empirical determinants of the relative yields on taxable and tax-exempt securities

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2023The Price of Safety: The Evolution of Municipal Bond Insurance Value 2009Municipal Debt and Marginal Tax Rates: Is there a Tax Premium in Asset Prices?2002Taxation, Risk-Taking, and Household Portfolio Behavior**I am grateful to Alan Auerbach, Scott Weisbenner, and participants at the Burch Center Symposium for helpful comments, to Andrew Mitrusi for providing me with data from TAXSIM, and to the Hoover Institution and National Science Foundation for research support.1996Do Municipal Bond Yields Forecast Tax Policy 1996Stock Market Yields and the Pricing of Municipal Bonds 2002How Prevalent is Tax Arbitrage? Evidence from the Market for Municipal Bonds

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