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Home  >  Transactions of NAMP VOL 14

11. OPTIMAL DEBT RATIO AND CONSUMPTION PLAN FOR AN INVESTOR UNDER INFLATION RISK AND CAPITAL GAINS TAX. by C.B. Ibe and K.E. Obie Volume 14, (January - March, 2021 Issue)
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OPTIMAL DEBT RATIO AND CONSUMPTION PLAN FOR AN INVESTOR UNDER INFLATION RISK AND CAPITAL GAINS TAX.

C.B. Ibe and K.E. Obie

Department of Mathematics, Faculty of Physical Sciences, University of Benin, P.M.B. 1154, Benin City, Edo State, Nigeria

Abstract

In this paper, we derive the optimal debt ratio and optimal consumption strategy for an investor whose asset price follows a diffusion process and capital gains are taxed. We put into consideration a market that is exposed to three background risks which include inflation, investment and income growth rate risks. Tax is levied on the payoff of the wealth process. Using dynamic programming principle and the CRRA utility function, we derive the optimal debt ratio and optimal consumption rate. We find the following: (i) optimal debt ratio is higher with taxation (ii) that optimal debt ratio is negatively impacted by increased volatility of both inflation and asset price risk (iii) that terminal consumption is positively related to the tax rate (iv) that a risk averse investor will have a decreasing optimal debt ratio.

JEL Classification: G11, G12, C02, C22, C61

Keywords: optimal debt ratio; corporation tax; inflation risk, jump risk

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