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Does Tax Convexity Matters For Risk? A Dynamic Study on Tax Asymmetry and Equity Beta
Keith Lam1; Adrian C. H. Lei1; Ho Yin Yick2
2012
Source PublicationReview of Quantitative Finance and Accounting
ISSN0924-865X
Volume41Issue:1Pages:131-147
Abstract

The objective of this paper is to examine the change of equity beta under different level of tax asymmetry in which firms face nonlinear tax schedules that potentially reduces their profitability. Tax convexity is an essential component in accounting practice but is usually overlooked in theoretical models. Under a convex tax schedule, profits are taxed at a higher rate while losses are taxed (rebated) at a lower rate. This paper presents a dynamic model based on the contingent claims framework to facilitate the relationship between beta and tax convexity. We verify that the overall effect of tax convexity on beta is positive and the effect would not be eliminated after incorporating other key determinants such as default option and growth option. Since asymmetric tax schedules are widely used in most countries, ignoring its change would understate the beta and fail to make accurate assessment of risk if the valuation framework simply assumes a symmetric tax schedule. The underestimation may last for a long time if analysts only adjust their estimation during significant changes of tax codes which seldom happens in a country. In conclusion, tax convexity should be taken into consideration in estimation of beta.

KeywordContingent-claim Model Growth Option Default Option Equity Beta Tax Asymmetry Tax Convexity
DOI10.2139/ssrn.1459711
Language英语
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Document TypeJournal article
专题DEPARTMENT OF FINANCE AND BUSINESS ECONOMICS
Affiliation1.University of Macau - Faculty of Business Administration
2.University of Hong Kong
First Author AffilicationFaculty of Business Administration
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Keith Lam,Adrian C. H. Lei,Ho Yin Yick. Does Tax Convexity Matters For Risk? A Dynamic Study on Tax Asymmetry and Equity Beta[J]. Review of Quantitative Finance and Accounting,2012,41(1):131-147.
APA Keith Lam,Adrian C. H. Lei,&Ho Yin Yick.(2012).Does Tax Convexity Matters For Risk? A Dynamic Study on Tax Asymmetry and Equity Beta.Review of Quantitative Finance and Accounting,41(1),131-147.
MLA Keith Lam,et al."Does Tax Convexity Matters For Risk? A Dynamic Study on Tax Asymmetry and Equity Beta".Review of Quantitative Finance and Accounting 41.1(2012):131-147.
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