We show that the level of interest rates determines the magnitude of mispricing at the turn of the tax year, as investors face the trade-off between selling a temporarily-depressed stock this year and selling next year, but delaying tax implications by one year. Interest rates do explain the predictable variation in US returns and selling behavior around the turn of the year. Similar results in the UK provide out-of-sample confirmation, as tax and calendar years differ. Moreover, part of the variation in the risks and abnormal returns of size, value, and momentum factors can be linked to tax-motivated trading.
Financial Markets Group Discussion Papers DP 671