A theory is advanced to explain the effects of rubber particle cavitation upon the deformation and fracture of rubber-modified plastics. The criteria for cavitation in triaxially-stressed particles are first analysed using an energy-balance approach. It is shown that the volume strain in a rubber particle, its diameter and the shear modulus of the rubber are all important in determining whether void formation occurs. The effects of rubber particle cavitation on shear yielding are then discussed in the light of earlier theories of dilatational band formation in metals. A model proposed by Berg, and later developed by Gurson, is adapted to include the effects of mean stress on yielding and applied to toughened plastics. The model predicts the formation of cavitated shear bands (dilatational bands) at angles to the tensile axis that are determined by the current effective void content of the material. Band angles are calculated on the assumption that all of the rubber particles in a band undergo cavitation and the effective void content is equal to the particle volume fraction. The results are in satisfactory agreement with observations recorded in the literature on toughened plastics. The theory accounts for observed changes in the kinetics of tensile deformation in toughened nylon following cavitation and explains the effects of particle size and rubber modulus on the brittle-tough transition temperature.