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On the destabilizing nature of capital gains taxes

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  • Dieci, Roberto
  • Gardini, Laura
  • Westerhoff, Frank

Abstract

Policymakers around the world impose some form of capital gains taxes to foster the stability of financial markets. Unfortunately, there is no clarity on the effects of capital gains taxes. Based on a stylized behavioral asset-pricing model highlighting the trading activity of extrapolating speculators, we show that policymakers may involuntary destabilize financial markets by imposing capital gains taxes. Most importantly, we find that the imposition of capital gains taxes may trigger endogenous cyclical asset price dynamics occurring around inflated price levels. A number of robustness checks in which we allow for interactions between speculators who use extrapolative and regressive expectation rules confirm our main results.

Suggested Citation

  • Dieci, Roberto & Gardini, Laura & Westerhoff, Frank, 2022. "On the destabilizing nature of capital gains taxes," International Review of Financial Analysis, Elsevier, vol. 83(C).
    • Handle: RePEc:eee:finana:v:83:y:2022:i:c:s1057521922002162
    DOI: 10.1016/j.irfa.2022.102258
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    More about this item

    Keywords

    Asset price dynamics; Capital gains taxes; Expectation formation; Systematic mispricing and excess volatility; Piecewise linear maps;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets

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