Death and Taxes: The Market for Flower Bonds

Authors

  • DAVID MAYERS,

  • CLIFFORD W. SMITH Jr.

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    • Shepard Professor of Insurance, College of Business, The Ohio State University, Columbus, OH 43210 and Professor, William E. Simon Graduate School of Business Administration, University of Rochester, Rochester, NY 14627, respectively. We would like to thank W. Bailey, J. Bodurtha, S. Buser, K. Chan, J. Ingersoll, C. Plosser, J. Shanken, M. Smith, F. Sterbenz, R. Walkling and R. Witt for comments and suggestions. This research was partially supported by the Managerial Economics Research Center, William E. Simon Graduate School of Business Administration, University of Rochester.

ABSTRACT

Certain U.S. Government securities, known as flower bonds, can be redeemed at par plus accrued interest for the purpose of paying estate taxes, if held at the time of death. Thus, a flower bond, selling at a discount, is like a straight bond plus a life insurance policy. An equilibrium derived from a rational flower bond pricing model implies the existence of clienteles: individuals with the highest death probabilities hold the deepest discount flower bonds. The empirical implication, that bonds with the deepest discount should be redeemed at the fastest rate, is tested and the results support the proposition.

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