Nonlinear taxation, tax-arbitrage and equilibrium asset prices (Q5939301)

It is developed a continuous-time model consisting of two (possibly) heterogeneous (in preferences, endowments and tax shedule) agents trading in an untaxed riskless bond that does not pays dividends and two redundant, taxed, dividend-paying risky securities (one of which presents stock and the other derivative). It is supposed that each agent derives a time-additive, state-independant utility \(u_{i}(c^{i}(t))\) \((c^{i}\)~is a consumption process, \(t \in [0,T]\)), where \(u_{i}\) is a three times continuously differentiable, strictly increasing, strictly concave function satisfying the equalities \(\lim _{c \to 0} u'(c) = \infty\) and \(\lim _{c \to \infty} u'(c) = 0\). The aim of agent \(i\) is to maximize \(E[ \int _{0}^{T} u_{i}(c^{i}(t))dt]\) over all admissible \((c^{i}, {\alpha}^{i})\) (\({\alpha}^{i}\) is a portfolio process) for which the expected integral is well defined. The purpose of the paper is to study the effects of tax-arbitrage on prices and allocations in an equilibrium framework. Under the supposition that the risk-weighted sum of holdings in the risky securities and the pre-tax mispricing are given it is extracted some set of portfolio prosesses to which an agent is indifferent. The optimal holding in the composite assest is derived. Optimization under progressive piecewice linear taxation is considered in details and is illustrated under logarithmic preferences of agents and the absence of actual stochastic endowment. In supposition that equilibrium exists and composite risk exposure choices of agents are given the expression for the mispricing is derived. The tax-relieving role of financial innovation is described for an equilibrium with a zero net supply security. The clientele effects are described for an equilibrium with two positive net supply securities.