Capital appreciation

Abstract: This paper studies expectations of capital appreciation in the housing market We show that expectations impounded in the rent/price ratio at the beginning of the decade successfully predict appreciation rates, but only if we first control for cross-sectional differences in the quality of rental versus owner-occupied housing We also demonstrate that observed rent/price ratios contain a disequilibrium component that also has power to forecast subsequent appreciation rates Finally, we provide evidence consistent with euphoria: participants in housing markets appear to overreact to income growth

Abstract: Taxation of asset returns can create various clientele effects. If every agent is marginal on all assets, no clientele effects arise. If some (but not every) agent is marginal on all assets, there arises a clientele effect in quantities but none in prices. If no agent is marginal on all assets, there arise clientele effects in both quantities and prices. In the first two cases, standard asset pricing and martingale results extend to analogous aftertax results. In the third case, linear asset pricing works only on subsets of assets, and the standard martingale results become after-tax supermartingale results. IN THE STUDY OF investments, taxes are largely a source of embarrassment to financial economists. We know that taxes are significant, but we do not know the equilibrium effect of taxes on asset pricing and the consequent effect on portfolio choice. Even partial equilibrium models such as that of Constantinides and Ingersoll [2] lead very quickly to numerical problems which make it hard to develop general intuition and effectively preclude testability on large data sets. The purpose of this paper is to develop some general concepts, intuitions, and useful simplifications concerning the effects of taxation. It is hoped that this will lead to a better understanding of related empirical phenomena, such as the January effect and the small firm effect, and to theoretical questions such as whether leverage pays.' An important concept often associated with taxation is that of a clientele effect, namely the notion that the behavior of different groups or clienteles of agents are qualitatively different. In this paper, we distinguish three different situations. The first situation, one of no clientele effects, is a situation in which all agents have an interior differentiable "marginalist" solution to their choice problems. This situation is the traditional situation of demand theory in the absence of taxes. In the second situation, one of a clientele effect in quantities but not in prices, at least some agents are on corners but all assets can be priced linearly. Consequently, there is at least a hypothetical agent on the margin. For example, there may be one marginal agent who has an interior solution, but there are other agents who are at a corner with only capital gains to the exclusion of income and vice versa. In the third or general situation, one of clientele effects in both quantities and prices, there are agents who face differing shadow prices of tax and income attributes because pricing is not linear. This general situation is * Yale University School of Management. We are grateful to Jon Ingersoll and Joe Williams for useful suggestions. 'Our analysis is consistent with (and draws heavily upon) past work by others on the effects of taxation on asset pricing. See Brennan and Schwartz [1]. Constantinides and Ingersoll [2], Miller [6], Modigliani and Miller [7, 8], and Schaefer [11]. 751 This content downloaded from 157.55.39.55 on Tue, 23 Aug 2016 04:38:57 UTC All use subject to http://about.jstor.org/terms 752 The Journal of Finance characterized by no agents wanting to hold all assets held by others, even at the margin, because of the differing tax implications. In this case, there can be no marginal agent. For example, if short sales are precluded, there may not be any hypothetical agent who would hold common stocks, corporate bonds, growth stocks, and municipal bonds at the same time. Wealthier investors hold municipal bonds (not taxed) and growth stocks (high capital gains and low income, taxed lightly). Simultaneously, poorer investors hold common stocks and corporate bonds (both high income and taxed heavily). In this case, as income rises, perhaps the investor switches first from common stock to growth stocks, and then from corporate to municipal bonds. No investor (real or hypothetical) would want to hold all four assets. This is a clientele effect in both pricing and quantities. Section I develops the analysis and displays examples of these different clientele effects. In the marginalist and marginal investor cases, there exist riskneutral probabilities and implicit tax rates under which all assets have the same after-tax expected return. This extends the usual no-arbitrage martingale result to a world with taxes. In the general case, no single set of risk-neutral probabilities and associated implicit tax rates can price all assets. Nonetheless, such pricing rules can price subsets, and the additional assets appear inferior. In technical terms, this gives us a super-martingale result that under each of these pricing rules all assets have expected return less than or equal to the shared constant. Section II extends the results to more general tax codes and discusses what happens when there are realized gains or losses from the past and each agent may have a different basis. Section III closes the paper. I. Taxation and Asset Pricing In our model, agents are precluded from short selling assets. This type of analysis makes it simple to study assets, like municipal bonds, which lose their tax advantage when shorted. This assumption is less restrictive than it might seem, because short sales of assets (with the same or different tax treatment) can be emulated by the introduction of new "artificial" assets, each consisting of a short position in a shorted asset plus a long position in another asset. The substantial restriction of the short sale restriction is in its interaction with the tax code. In this section, we assume that taxes are a function of an aggregate called taxable income and that each asset has income or losses that contribute to taxable income at a constant rate (that can vary across both states and assets).2 Section II analyzes the more general case with multiple sources of taxed income. Here is the basic structure of the model. While we are analyzing a one period model, we can think of the one period as being embedded in a longer intertemporal model.3 To distinguish the price of the asset at the beginning and end of the period, we will call the beginning t and the end t + 1, and we define pt to be the 2 An alternative approach is to assume that principal is taxable as well as gains. That approach is just as tractable (and perhaps slightly simpler), but we feel that it is more reasonable to have the agents pay taxes only on gains and losses. 'In general, with many periods the value function will depend on the end-of-period holding and the basis of assets held as well as the end-of-period wealth. For now, we are ignoring bases and are assuming we will sell all assets at the end of one period. This content downloaded from 157.55.39.55 on Tue, 23 Aug 2016 04:38:57 UTC All use subject to http://about.jstor.org/terms Tax Clienteles and Asset Pricing 753 price of asset i at the beginning and pt1 (positive) to be the price of asset i at the end in state 0. The price at t + 1 is assumed to include any payout (e.g., dividend, coupon, or split) that is given by the agent, as well as capital appreciation. In state 0, a fraction PiO (between 0 and 1) of the gain (or loss) to holding asset i counts as ordinary taxable income (or offset). The dependence of this fraction on the state is for generality, and, for example, allows the mix between coupon income and capital gains (which are taxed at different rates) to be different in different states. Each agent has a von Neumann-Morgenstern utility function, u(.) (assumed to be increasing, concave, and differentiable), and initial wealth, wt. For economy of notation, we will not index explicitly by investor. The probability that state 0 will occur is iro > 0, which can be interpreted as subjective or objective. For exposition, we will assume that all agents have the same probabilities, but it will be clear from the proofs that all that is really necessary is that agents agree which states have positive probability. Let ai be the number of shares of asset i in the portfolio. The function t(.) (convex and differentiable, with t(O) = 0 and O < t' < 1) gives the amount of taxes paid as a function of taxable income. Each agent solves a problem of the following form. PROBLEM 1 Choose ai's (and implicitly co's and ye's) to maximize Ee i7rou[ce t(ye)] subject to:

Abstract: Classical models predict that the division of stock returns into dividends and capital appreciation does not affect investor consumption patterns, while mental accounting and other economic frictions predict that investors have a higher propensity to consume from stock returns in the form of dividends. Using two micro data sets, we show that investors are indeed far more likely to consume from dividends than capital gains. In the Consumer Expenditure Survey, household consumption increases with dividend income, controlling for total wealth, total portfolio returns, and other sources of income. In a sample of household investment accounts data from a brokerage, net withdrawals from the accounts increase one-for-one with ordinary dividends of moderate size, controlling for total portfolio returns, and also increase with mutual fund and special dividends. We comment on several potential explanations for the results.

Abstract: Because of the scope of the study, it is not possible to make general statements about the exact variables which should be used in client-specified valuation models. However, the interpretation of the results of the study suggests several tentative conclusions.First, the investor's investment analysis of common stock appears to be a multi-dimensional process. That is, more than one decision variable is involved in the analysis. Hence, it may be reasoned that client-specified valuation models should involve several independent variables.Second, the dividends factor is the most important of the three factors identified through factor analysis. This finding suggests large differences in perceptions among investors concerning the importance of dividends.Third, future expectations and financial stability are the other factors identified through factor analysis. These factors also represent areas of large perceptual differences among investors concerning their importance.Finally, investors are of two distinct types: those who seek dividends and those who seek capital appreciation. This finding provides a partial explanation for the inability of researchers using traditional methodology to predict a firm's stock price behavior. Thus, investors do not comprise a single homogeneous class. This suggests that certain types of stocks prove attractive to particular types of investors, i.e., a "clientele effect." Hence, it is recommended that researchers interested in share price research segment the market by class of investor. Such investigation of investor socioeconomic and behavioral characteristics should prove worthwhile in providing a greater understanding of the factors influencing investor behavior.