This study estimates the after-tax term structure of real interest rates using the prices of UK linked and non-linked gilts over the period from 25 January 1986 until 25 October 1993. The impact of differential taxation and the existence of “noise” in observed market prices is found to produce a significant impact on the parameter estimation of term structure models when compared to methods, such as Brown and Schaefer (Brown, R., Schaefer, S., 1994. Journal of Financial Economics 35, 1–42), that did not. Two major observations can be made regarding the estimates for spot real interest rates. Firstly, the volatility of the short-term rate is much lower than that found by Brown and Schaefer (1994) which provides a better fit with the predictions of the CIR single factor model for interest rates. Secondly, consistent with Rumsey (Rumsey, J., 1993. An impact of the assumptions about taxes on the estimation of the properties of interest rates. Working Paper), there appears to be some evidence to suggest that single factor interest rate models produce a better fit to interest rates on an after-tax basis than on a before tax basis.

This paper investigates tax effects in the Canadian government bond market during the period 1964—1986. Unlike previous studies, we apply both statistical and nonstatistical teststo analyze clientele effects and market equilibria. The results divide the sample into two distinct periods of time, with the end of 1976 marking the division. We find that tax effects are almost nonexistent in the Canadian government bond market before the end of 1976, but are predominant in the post-1976 period. Non-segmented market equilibria cannot be rejected before 1977, but are strongly rejected after 1976. In fact, segmented equilibria with clientele effects in both quantities and prices characterize the entire five year period from 1982 to 1986. These findings are consistent with tax reforms, government deficit financing and interest rate fluctuations in Canada during our sample period.