Taxes, Order Imbalance and Abnormal Returns around the ex‐Dividend day

• Published in: International review of finance Vol. 18; no. 3; pp. 379 - 409
• Main Authors: Ainsworth, Andrew B., Fong, Kingsley Y.L., Gallagher, David R., Partington, Graham
• Format: Journal Article
• Language: English
• Published: Melbourne John Wiley & Sons, Ltd 01.09.2018; Blackwell Publishing Ltd
• Subjects: Arbitrage; Tax credits
• ISSN: 1369-412X; 1468-2443
• DOI: 10.1111/irfi.12155

A costly arbitrage model, developed for the Australian imputation tax system, shows that stocks paying dividends with a tax credit are likely targets for ex‐dividend arbitrage. We show that order imbalance, based on the direct observation of buyer and seller initiated trades, is a key factor in price movements around the ex‐dividend day. Buying pressure before the ex‐dividend day aimed at capturing the dividend and tax credit leads to an increase in prices that subsequently reverse in the ex‐dividend period. This effect is concentrated in those stocks distributing a tax credit with their dividend payments. The price pressure resulting from order imbalance is substantially higher around the ex‐dividend day relative to the effect observed outside this period. Our results reject the model of Frank and Jagannathan () that bid‐ask bounce is responsible for the ex‐day premium and provide support for explanations based on taxes, transaction costs, and incomplete price adjustment on the ex‐day.