Equilibrium Pricing of Special Bearer Bonds

Indian Institute of Management Ahmedabad, Research and Publication Department, IIMA Working Papers 01/1989;
Source: RePEc


In 1981, the Government issued Special Bearer Bonds under a scheme which allowed people to invest their black money in these bonds and enjoy freedom from investigations and prosecutions for tax evasion in respect of their holdings of these bonds. Through these bonds are no longer available in tap, there is an active secondary market for these bonds; the complete anonymity of these bearer bonds has helped to make them quite liquid. This paper derives equilibrium prices of these bonds in the secondary market. The entire analysis is carried out in a continuous time framework using the mixed Wiener-Poisson process; the Capital Asset Pricing Model (CAPM) is employed in a modified form which accounts for the fact that, for black money investors, investment in any asset other than the bearer bond involves the risk of tax penalties in addition to the usual investment risks. The existence of the bearer bond helps to analyze the impact of black money on the capital market in general; in this setting it is shown that the pricing of risky assets relative to each other and relative to the white risk free bonds is unaffected by the presence of black money. This provides justification for using the CAPM in corporate finance and portfolio management in a capital market like India where black money is widespread. Out results can be useful for estimating the magnitude of black money and the degree of tax enforcement; it can also help the Government in pricing any fresh issues of such bonds in future.

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    ABSTRACT: In this paper we present a review of research done in the field of Indian capital markets during the fifteen years from 1977 to 1992. The research works included in the survey were identified by two search procedures. Firstly, we wrote to 118 Indian university departments and research institutions requesting information on the works done in this field in their department/institution. After three reminders, we obtained responses from 53 institutions. Simultaneously, we searched through various Indian journals in our library, located books listed in the library catalogue and traced through the list of references provided in various research works. Considering the size, vintage and development of the Indian capital market, the total volume of research on it appears to be woefully modest - about 0.1 unit of work per institution per year! Moreover, a large number of works are merely descriptive or prescriptive without rigorous analysis. Certain areas such as arbitrage pricing theory, option pricing theory, agency theory, and signalling theory are virtually unresearched in the Indian context. Besides, very little theoretical work has been done by researchers in India. However, with improved availability of databases and computing resources, and with increasing global interest in Indian markets, we expect an explosion of work in the near future.


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