Dynamic Tax Evasion with Habit Formation in Consumption*

We model the optimal intertemporal decision of an agent who chooses tax evasion and consumption, over an infinite lifetime horizon, where consumption is driven by habits. We find the following: (i) tax evaders reduce consumption in the early stages of habit accumulation and increase it over time; (ii) habit formation has a dampening effect on tax evasion; (iii) neglecting tax evasion can lead to habit overestimation; (iv) the effect of the tax rate on tax evasion is ambiguous; (v) heavy fines are more efficient than frequent controls in reducing tax evasion.     

Optimal Portfolios with Credit Default Swaps

Using a continuous-time, stochastic, and dynamic framework, this study derives a closed-form solution for the optimal investment problem for an agent with hyperbolic absolute risk aversion preferences for maximising the expected utility of his or her final wealth. The agent invests in a frictionless, complete market in which a riskless asset, a (defaultable) bond, and a credit default swap written on the bond are listed. The model is calibrated to market data of six European countries and assesses the behaviour of an investor exposed to different levels of sovereign risk. A numerical analysis shows that it is optimal to issue credit default swaps in a larger quantity than that of bonds, which are optimally purchased. This speculative strategy is more aggressive in countries characterised by higher sovereign risk. This result is confirmed when the investor is endowed with a different level of risk aversion. Finally, we solve a static version of the optimisation problem and show that the speculative/hedging strategy is definitely different with respect to the dynamic one.     

Would less regional income distribution justify the present call for devolution?

We model a local public good with spillovers, in a framework where devolution is socially inefficient. Nevertheless, we show that decentralisation may be preferred by one region if it implies a reduction in regional income redistribution. This result is due to the inter-regional mechanism of the equalisation grant. For an expenditure-based grant, we define a threshold for regional income disparity above which decentralisation is preferred, while for a resource-based grant the threshold depends on the spillover and the difference in preferences for the local public good. Finally, for given levels of regional income disparity we show which grant form may minimise the claims for decentralisation.     

Optimal dynamic tax evasion

We study optimal dynamic tax evasion in the framework proposed by Lin and Yang (2001) and Dzhumashev and Gahramanov (2011) with some modifications: a more flexible utility function, a more realistic audit process, and a penalty function which can be defined both on evaded income and evaded taxes. In the former case the elasticity between tax rate and tax evasion is positive, unless the subsistence consumption level is higher than a given threshold. In the latter case the relationship is usually negative , but the value of elasticity depends on the form of absolute risk aversion. In particular we show that for increasing relative risk aversion, for a tax rate higher than 50%, the elasticity may even become positive. US data are consistent with IRRA preferences.     

Optimal portfolio and spending rules for endowment funds

Review of Quantitative Finance and Accounting - Prior studies show that investor learning about earnings-based return predictors from academic research erodes return predictability. However, the...