TAX‐TIMING OPTIONS AND THE PRICING OF GOVERNMENT BONDS

Internal Revenue Code provisions affect trading strategies for long‐term, fixed‐payment securities when investment income is subject to taxation and can create tax‐timing options of varying nontrivial values for specific bonds at specific times. In this paper, an estimate of the tax bracket of the marginal investor is used to measure the relative impact of changing tax‐timing option values on government bond prices. Results support the argument that tax‐timing options help to explain an apparent discrepancy between theoretical arguments regarding the tax bracket of the marginal investor and observed market relationships.