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Uncertain tax rules and futures hedging

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  • Donald Lien

    (Department of Economics, University of Kansas, Lawrence, KS, USA)

Abstract

This paper considers the optimal futures hedging decision under uncertain tax treatment. If the Corn Products (CP) rule applies, gains or losses from futures trading can offset business gains or losses. However, under the Arkansas Best (AB) doctrine, offsetting is not allowed. We show that the risk neutral firm will not trade futures contracts if the probability the CP rule prevails is small. When the probability is sufficiently large, the firm will assume an underhedge. A risk averse firm is likely to trade, even if the AB rule prevails. As long as the CP ruling is not a sure thing, the firm will engage in underhedge. The effects of average business profits, the volatility of business profits, and risk aversion on the optimal futures position are provided. Copyright © 1999 John Wiley & Sons, Ltd.

Suggested Citation

  • Donald Lien, 1999. "Uncertain tax rules and futures hedging," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 20(8), pages 429-436.
    • Handle: RePEc:wly:mgtdec:v:20:y:1999:i:8:p:429-436
    DOI: 10.1002/1099-1468(199912)20:8<429::AID-MDE959>3.0.CO;2-M
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    References listed on IDEAS

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    1. Milevsky, Moshe Arye & Prisman, Eliezer Z., 1999. "Hedging and pricing with tax law uncertainty: Managing under an Arkansas Best doctrine," The Quarterly Review of Economics and Finance, Elsevier, vol. 39(1), pages 147-168.
    2. Purcell, Wayne D., 1992. "Research on Implications of IRS Policies to the Effectivemess of Cattle Futures Markets," Staff Papers 232408, Virginia Polytechnic Institute and State University, Department of Agricultural and Applied Economics.
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    Cited by:

    1. Donald Lien, 2004. "A Note on Dual Hedging," International Journal of Business and Economics, School of Management Development, Feng Chia University, Taichung, Taiwan, vol. 3(1), pages 29-34, April.

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