Volume 14, Number 4, 2016
After-tax performance measurement requires a rigorous definition of after-tax portfolio value, which is also a prerequisite for effective portfolio management.
The focus of this paper is the tax option, which is the right to execute tax-beneficial transactions. This option is a critical component of after-tax portfolio value. Some of the proposed definitions incorporate the intrinsic value of the tax option. However, the time value of the option has not been explicitly considered previously. Incorporating the time value of an option is in line with contemporary finance theory, and it provides a more accurate assessment of after-tax value. The tax option can be valued using standard models appropriate to the asset under consideration, but incorporating investor-specific parameters such as tax rates and mortality rates.