The Journal of Finance publishes leading research across all the major fields of finance. It is one of the most widely cited journals in academic finance, and in all of economics. Each of the six issues per year reaches over 8,000 academics, finance professionals, libraries, and government and financial institutions around the world. The journal is the official publication of The American Finance Association, the premier academic organization devoted to the study and promotion of knowledge about financial economics.
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Was the Tax‐Exempt Bond Market Inefficient or Were Future Expected Tax Rates Negative?
Published: 09/01/1988 | DOI: 10.1111/j.1540-6261.1988.tb02612.x
LEVIS A. KOCHIN, RICHARD W. PARKS
This paper shows that the sharp narrowing with maturity of the spread between taxable and tax‐exempt yields leaves room for tax arbitrage. At times, tax‐exempt forward rates have exceeded taxable forward rates. At such times, only expectations of higher taxes on Treasury than on municipal bonds would eliminate profit opportunities. The authors develop the idea of forward tax rates and compute forward tax rates for 1955 through 1984. They also outline tax‐arbitrage mechanisms involving private forward sale of long municipal bonds or the use of the Municipal Bond Futures Contract and show the potential profits.