Ex-day behavior with dividend preference and limitations to short-term arbitrage: the case of Swedish lottery bonds

Swedish lottery bonds offer a unique opportunity to study ex-day effects in an environment where cash distributions are tax-advantaged relative to capital gains. Thus, in the lottery bond market, we observe a reversal of the preference for capital gains that researchers have cited as an explanation for the ex-day behavior of U.S. equities. Further, in this market there are barriers to short-term arbitrage when prices do reflect the tax preferences of individual investors. We find the bonds are priced around the ex-day to reflect differential tax rates on income and capital gains consistent with the prevailing tax regimes. The bonds consistently experience negative returns over the coupon payment period, and in fact often sell at negative yields prior to the cash distribution, as one would expect given tax-motivated trading between high-tax investors, who buy prior to the distribution, and low-tax investors, who buy after the distribution. (C) 1999 Elsevier Science S.A. All rights reserved.