Literature Reviews

Harvey et al. (2015) 

The study conducted by Harvey, Liu, and Zhu in 2015 was one of the first investigations that tried to explore the cross-section of expected returns by using new multiple testing frameworks. For their analysis, Harvey et al. used only those studies, which proposed and tested new factors. As the authors focused on the analysis of the factors, which could correctly explain the return patterns, they excluded corporate finance studies, investigating a small group of stocks. The survey conducted by Harvey et al. revealed that despite the fact that the frameworks under analysis differed in their assumptions, they were still consistent in their conclusions. Harvey et al. emphasized the fact that a newly discovered factor in the contemporary studies of finance should have a t-statistic, which exceeded the score of 3.0. To understand the issue, Harvey et al. provided excerpts from the empirical tests covering the period from 1967 to 2015. Their analysis of factor discoveries implied that a substantial part of the factors revealed in the field of economy were false discoveries as nearly half of the published factors might be considered inaccurate. The study is significant to the academic community since it identified erroneous investigations, as well as evaluated the surveys that contained inefficiencies and bias in the studies of cross-sectional regression.

Miller and Scholes (1982) 

The study conducted by Miller and Scholes in 1975 focused on the reevaluation of the tests that explored whether the holders of shares, which included higher dividend yields and short-term capital profits, received much higher risk-adjusted return levels to pay for the higher taxes on dividend payables than the ones with long-term capital profits did. Miller and Scholes reexamined Black and Scholes’ study of 1974, which did not find any substantial relationship between stock returns and dividend payout or dividend yield. To gain accurate results, the study employed the method of testing the effects of yield-related taxes, including the tests referring to the capital-asset pricing model, which used Fama-MacBeth’s method of 1973 with regard to the time-series pooling process of cross-sectional coefficients. Miller and Scholes’ study found out that returns were directly related to dividend yields, being sensitive to the rate of dividend yield. The authors showed that the difference in estimated yield effects directly reflected the distinction in the level to which some short-run measurements of expected dividend yield introduced the possible effects of unwanted data. Miller and Scholes’ investigation is important to the field of finances since it proved that the yield-related effects for short-run measures were biased. The authors also provided valuable information that explained why the tests, which relied on short-run responses to dividend payments, could not offer correct measurements of the impact of a tax penalty on dividends. 

Mcculloch (1975)

Mcculloch’s study of 1975 focused on the modification of the previously explored technique by the author regarding the way regression could fit the term structure of interest rates. The investigation +aimed at reconciling the observations on low and high coupon bonds, as well as eliminating tax-induced bias developed by Robichek and Niebuhr who argued that it could significantly change the shapes of yield curves if they were produced from quotations on bonds selling below the nominal value of securities. To test the hypothesis, the study used a cubic spline that gave a smooth shape to the forward curve. In his research, Mcculloch found out that tax-adjusted bond yield curve should exclude Robichek and Niebuhr’s tax-induced bias to provide an accurate and reliable assessment of the coupon rate necessary to float new debt at the nominal value of securities. The results regarding the effects of differential taxation of long-term and ordinary capital profit income implied that the unexplained variance could be significantly reduced when the term structure of interest rates reached the level of at least 92%. The findings were significant to the academic community since they showed that the interest rates, linked to the point payment yield curve, should be free from such distortions as Robichek and Niebuhr’s tax-induced bias, to avoid reversing inferences with regard to the direction in which the market expected interest to exist.

Nelsonand and Siegel (1987) 

Nelsonand and Siegel’s study of 1987 introduced a simple model known as a parametrically parsimonious model that defined yield curves, thereby providing an opportunity to represent the shapes linked to humped, monotonic, as well as S-shaped yield curves. According to the research, the potential applications of the developed model involved the analysis of the theories regarding the term structures of interest rates, demand functions, and graphic illustrations of informative purposes. Nelsonand and Siegel applied their second-order model to determine  the relationship between yield and term with the aim of assessing the maturity of the U.S. Treasury bills. The pilot testing of data concerning the American Treasury bill showed that a simple model involving only a single-shaped parameter could effectively and accurately characterize the shapes of the bill term structures. In addition, the model imposed sufficient smoothness that assisted in revealing maturity-specific patterns associated with lower transaction costs for the Treasury bills. Using the model, Nelson and Siegel discovered a close link between the value of long-term bonds and the actually defined price of those bonds. Their model was significant to the field of finances and economy as it helped explain approximately 96% of the variations in bill yields across maturities fixed from 1981 to 1983. Additionally, the movement of parameters through time helped assess the changes in the Federal Reserve monetary policies during 1982.

Poterba and Samwick (2002) 

The study conducted by Poterba and Samwick in 2002 examined the relation among the portfolio shares, the set of financial assets of each household, as well as the marginal income tax rates of households. In their study, the authors used data concerning high net worth households to define how taxes might impact portfolio choices of households in terms of financial assets. Poterba and Samwick analyzed the data taken from the investigations conducted by The Survey of Consumer Finances from 1983 to 1998. In addition, they developed a new algorithm that helped impute the federal marginal rates of tax to households in those surveys. The findings implied that effective marginal rates of tax had a substantial influence on the decisions concerning asset allocations. Poterba and Samwick’s study showed that the set of financial assets owned by the household had a direct relation to the share of the portfolio that the households allocated to a number of financial assets. As there had been relatively few empirical studies exploring the way taxation affected portfolio allocation, Poterba and Samwick’s work was significant for the academic community. 

Dammon et al (2004)

The study conducted by Dammon, Spatt, and Zhang in 2004 focused on the examination of location decisions and possible asset allocation of the investors who had both tax-deferred and taxable chances for investing into various spheres. Dammon et al. used the theoretical results concerning the optimal asset location of asset holding to determine the asset location policy, which could produce the expected beneficial utility of after-tax wealth for investors. The study also designed a model to evaluate the influence of liquidity shocks, municipal bonds, as well as borrowing and short-term constraints, on the optimal asset location policy. Their findings implied that even in cases where equity produced a high ordinary income, the value of tax-timing options was high enough to solve the problem of the higher yield. The results also showed that while investors located taxable bonds in the tax-deferred retirement accounts, they located equity in their taxable accounts. Dammon et al. revealed that there existed an asset location puzzle, which demonstrated that the asset location decisions in practice considerably deviated from the results of the designed model. The results of the study were important to the academic community since they proved that each investor might gain significant benefits from shifting the location of his or her asset holdings to the developed tax-efficient policies. 

Zhou (2009)

Zhou’s study of 2009 focused on the examination of the asset location puzzle. According to Zhou, in practice, asset location decisions t significantly differed from the predictions made by the theoretical models. The study developed a life cycle model involving a progressive tax system that carried out a quantitative evaluation of the two definiions of the asset location puzzle. The results implied that the portfolio choices that households made included labor income uncertainty, progressive tax codes, short-sale and borrowing constraints, as well as various tax treatments for both tax-deferred and taxable accounts. Zhou’s study suggested that such households should make asset allocation decisions and asset location decisions simultaneously. Zhou found out that taxes played a crucial role in making decisions referring to the process of asset location. The results showed that the realization of capital profits was essential for defining the optimal location of assets as it significantly affected the effective tax rate on stock returns and the possible benefits gained from pre-tax accumulations of stock returns. The findings of the study were important to the field of finances as they provided an insight into the understanding that households’ optimal asset location decisions were essential for both increasing the level of the U.S. net wealth and tax-deferred accounts of the national economy.