This paper examines one of the few cases of seemingly redundant securities: sets of three government bonds with the same maturity date. Within the bounds on relative bond prices established by tax-exempt investors in a market with proportional transaction costs, the taxation of capital gains on the basis of realization has a significant impact on relative prices. The empirical evidence supports the tax option effect discussed by Constantinides and Ingersoll, but does not generally support the segmented tax-clientele equilibrium discussed by Schaefer.

It is shown that coupon bonds alone are not sufficient to span time‐dated claims on ordinary income, capital gains, and non‐taxable wealth. In an incomplete bond market where the pure dated claims are not spanned by existing bonds, marginal rates of substitution between present consumption and pure dated claims on ordinary income, capital gains income, and non‐taxable wealth, respectively, can differ across bondholders. However, the relative pricing of coupon bonds in each of these countries is shown to be consistent with the tax status of the major (non‐tax‐exempt) holders of government debt.