The purpose of this study is to investigate whether investor risk increases during the legislative process preceding the Tax Reform Act of 1986. A secondary objective is to investigate differences between industries with respect to changes in risk coincident with tax reform announcements.; The ex ante standard deviation of stock prices generated under both the explicit finite difference and the Black and Scholes option pricing models was used as the proxy for investor risk. Also, the implicit standard deviation (ISD) in each of these option pricing models was calculated for both at-the-money and 10% in-the-money options. Under each of the models, the difference in the logarithmically adjusted ISD's on the day before and on the day of certain tax announcements was used as the dependent variable. An analysis of variance was used to assess the impact of seven tax announcements across seven industry groupings on the dependent measure calculated under each model.; The dependent measures calculated using each of the four models were significantly correlated with each other. Although many results were mixed, all four models generated statistically significant results corresponding to the announcement of the House Ways and Means bill on November 23, 1985. The explicit finite difference models found more pronounced results for this effect than those found in the Black and Scholes models.; Although the incidence of tax reform can be measured using a one-day event window, the economic significance of such a short time span can be questioned. Therefore, another analysis averaged the test statistic over two five-day periods before and after the announced House bill. Both univariate and multivariate tests found this event significant only with respect to the other non-tax preference industry grouping. Therefore, stock prices in tax preference industries appear more efficient than security prices in non-tax preference industries in responding to tax news.; The implications for tax policy appear clear. Because the Financial Accounting Standards Board and the Securities Exchange Commission consider the stock market impact of their pronouncements, Congress and the Treasury Department should also consider the market response to tax changes.
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