Taxation and Asset Pricing in a Production Economy: Working Paper 2008-10

November 25, 2008
Working Paper
This paper studies the asset pricing implications of dividend and corporate income taxes in a stochastic general equilibrium model with production similar to Jermann (1998).

Summary

Maria I. Marika Santoro and Chao D. Wei

This paper studies the asset pricing implications of dividend and corporate income taxes in a stochastic general equilibrium model with production similar to Jermann (1998). In particular, we ask whether those two types of taxes introduce additional tax-related risk factors in the economy, and how the equity premium may be affected. We find that proportional dividend taxes introduce no additional risk factors and, as a result, have no impact on the equity premium. By contrast, corporate income taxes have strong implications for asset pricing. Key economic variables, including consumption, dividends, and investment, are more volatile in a general equilibrium model with corporate income taxes. Thus, a larger equity premium is required to compensate for the risk brought about by such taxes.