Investors’ preference for a positive tax rate depends on the level of the interest rate

Abstract

In a financial market with only one stock, Cadenillas and Pliska (Financ Stoch 3:137–165, 1999) showed that sometimes investors can take advantage of a positive tax rate to maximize their portfolio return. Buescu et al. (Math Finance 17:477–485, 2007) generalized this surprising result to a market with one stock and one bank account with zero interest rate. We consider instead a financial market with one stock and one bank account with positive interest rate. As in the papers above, we assume that there are taxes and transaction costs in the financial market. We succeed in solving the problem of an investor who wants to maximize the long-run growth rate of his investment, even though the positivity of the interest rate increases the dimensionality of the problem and the difficulty of the computations. We characterize how the investors’ preference for a positive tax rate depends on the interest rate level: investors prefer a positive tax rate when the level of the interest rate is low, and the opposite occurs when the level of the interest rate is high.