Experimental Evidence on the Effects of Tax Incentives on Risky Security Prices.

Abstract The price of an asset is influenced by both its riskiness and its tax treatment. This study examines the effects of risk and tax treatment on asset prices by conducting an experimental market. Two different forms of tax incentives are examined: preferential treatment of capital gains and an unlimited deduction for capital losses. The study found that securities with favorable tax treatment were higher priced than equally risky, non-tax-favored securities. There was no difference in the price of a high-risk, tax-favored security and a lower-risk, fully-taxable (benchmark) security when the tax-favored security received only one tax benefit. Risky securities receiving favorable capital gain and loss treatment were higher priced than the benchmark security. However, these results are dependent upon the actual magnitudes of the tax rates studied.