Valuation of Callable Bonds under Progressive Personal Taxes and Interest Rate Uncertainty

Abstract

The principal focus of the analysis is on the valuation of a call provision on a bond in an environment wherein investors have progressive tax rates which positively covary with interest rates. Under the conditions of Miller's bond market equilibrium, it is shown that the decision to issue a callable bond is a negative sum game from the corporation's perspective. Empirical evidence on the extent to which tax rates and interest rates positively covary indicates that the tax effect analyzed here is likely to be economically significant.