Marc Steffen Rapp, Bernhard Schwetzler

• Abstract: We analyze the impact of the prevailing tax rate upon the risk neutral probability measure that transforms assets into a fair game"". Therefore we assume a linear tax system using the economic rent as tax base and apply the consumption-based asset pricing framework on a two-date economy with representative agents and perfectly inelastic supply of risky assets. Analyzing taxation we account for all effects of public policy with respect to the agent's portfolio choice problem, that is we also consider the redistribution of funds by the tax authority. The results are threefold: first, in general the risk neutral probability measure depends on the prevailing tax rate. Second, there is a bundle of - rather strict - assumptions that ensures the risk neutral probability measure to be independent of the prevailing tax rate. This implies an extended version of the neutrality result of Samuelson (1964). Finally, it is by no means obvious that the (after-tax) cost of capital of an asset is linear or decreasing in the tax rate. Keywords: taxation, valuation, risk neutral probability measure JEL Classifications: D50, G12, G31 The paper can be downloaded from the Social Science Research Network Electronic Paper Collection: http:papersssrncomsol3paperscfmabstract_id="547384" target="_blank" href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=547384">http://papers.ssrn.com/sol3/papers.cfm?abstract_id=547384</a>