Kraus and Stoll find evidence for some form of distribution effect. Mikkelson & Partch

(1985), Hess & Frost (1982), and Harris & Gurel (1986) also find empirical evidence

supporting the PPH.

Imperfect Substitute Hypothesis

 The second hypothesis that supports price changes in response to excess demand is

the Imperfect Substitute Hypothesis (ISH). The ISH is developed as the second

distribution effect discussed by Kraus & Stoll (1972). This effect is due to different

investor preferences for a given security. This is a permanent price effect, and depends on

the number of investors and on the substitutability of one security for another. In public

securities markets, the Imperfect Substitute Hypothesis allows for equilibrium price

changes to eliminate the excess demand. Evidence of demand induced price shocks can

be found in the impact of large block trades on prices (Scholes (1972), Kraus and Stoll

(1972) and Mikkelson and Parch (1985)).

 Section 1031 exchanges may create a similar tax-induced demand shock. In

particular, the compliance risk in delayed exchanges could create increased acquisition

demand, which may force the taxpayer to share some of the expected tax-deferral benefits

with the seller of the replacement property in the form of an increased purchase price. In

addition, if the seller of the replacement property is aware that the taxpayer is seeking to

complete a tax-deferred exchange, the taxpayer's bargaining position is clearly

compromised.

Tax Capitalization Hypothesis

 In competitive markets, the value of commercial real estate fully reflects the current

and expected future tax treatment of depreciable assets (Hendershott and Ling, 1984, and

Ling and Whinihan, 1985). Expected increases in tax liabilities are capitalized in the