Tax Effects in Term Structure Estimation

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Abstract
This study is a refinement and an extension of an earlier study by McCulloch of tax effects in the regression equation for term structure estimation. This study includes tests for tax effects and heteroskedasticity, a reconsideration of the need for an instrumental variable, and a search for the capital gains tax rate in addition to the ordinary‐income tax rate. There are two major findings: (1) statistically significant tax‐induced bias in the non‐tax‐adjusted equation and (2) evidence that the capital gains tax is misspecified in the tax‐adjusted equation.

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