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 cap ital 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 preference s of individual investors. We find the bonds are priced around the ex-day t o reflect differential tax rates on income and capital gains consistent wit h the prevailing tax regimes. The bonds consistently experience negative re turns over the coupon payment period, and in fact often sell at negative yi elds prior to the cash distribution, as one would expect given tax-motivate d trading between high-tax investors, who buy prior to the distribution, an d low-tax investors, who buy after the distribution. (C) 1999 Elsevier Scie nce S.A. All rights reserved.