Taxes, clientele effect of dividend and risk, return linearity

This paper extends the equivalence relationship between risk/return linearity and portfolio efficiency as derived in Roll (1977) to the case where there is differential taxation affecting investors optimal portfolio choice. Following the formulation of Brennan (1970a), the fundamental linearity relationship is derived which raises serious doubts to the testability of the extendedCAPM that accounts for the effect of differential taxation. Finally by aggregating other imperfections as well as differential taxation into a dividend yield constraint, a different version of theCAPM is derived which offers alternative interpretations of the existing empirical results on the subject.