Abstract

http://ssrn.com/abstract=2374966
 


 



Tax-Aware Dynamic Asset Allocation


Martin Haugh


Columbia University - Department of Industrial Engineering and Operations Research (IEOR)

Garud Iyengar


Columbia University - Department of Industrial Engineering and Operations Research (IEOR)

Chun Wang


Columbia University - Department of Industrial Engineering and Operations Research (IEOR)

March 16, 2014


Abstract:     
We consider dynamic asset allocation problems where the investor is required to pay capital gains taxes on her investment gains. This is a very challenging problem because the tax to be paid whenever a security is sold depends on the tax basis, i.e. the price(s) at which the security was originally purchased. This feature results in high-dimensional and path-dependent problems which cannot be solved exactly except in the case of very stylized problems with just one or two securities and relatively few time periods. The asset allocation problem with taxes has several variations depending on: (i) whether we use the exact or average tax-basis and (ii) whether we allow the full use of losses (FUL) or the limited use of losses (LUL). We consider all of these variations in this paper but focus mainly on the exact and average-cost tax-basis LUL cases since these problems are the most realistic and generally the most challenging. We develop several sub-optimal trading policies for these problems and use duality techniques based on information relaxations to assess their performances. Our numerical experiments consider problems with as many as 20 securities and 20 time periods. The principal contribution of this paper is in demonstrating that much larger problems can now be tackled through the use of sophisticated optimization techniques and duality methods based on information-relaxations. We show in fact that the dual formulation of exact tax-basis problems are much easier to solve than the corresponding primal problems. Indeed, we can easily solve dual problem instances where the number of securities and time periods is much larger than 20. We also note, however, that while the average tax-basis problem is relatively easier to solve in general, its corresponding dual problem instances are non-convex and more difficult to solve. We therefore propose an approach for the average tax-basis dual problem that enables valid dual bounds to still be obtained.

Number of Pages in PDF File: 29

Keywords: Dynamic asset allocation, taxes, sub-optimal control, duality, information relaxations

JEL Classification: G11, C44, C61, C63

working papers series


Download This Paper

Date posted: January 6, 2014 ; Last revised: March 19, 2014

Suggested Citation

Haugh, Martin and Iyengar, Garud and Wang, Chun, Tax-Aware Dynamic Asset Allocation (March 16, 2014). Available at SSRN: http://ssrn.com/abstract=2374966 or http://dx.doi.org/10.2139/ssrn.2374966

Contact Information

Martin Haugh (Contact Author)
Columbia University - Department of Industrial Engineering and Operations Research (IEOR) ( email )
331 S.W. Mudd Building
500 West 120th Street
New York, NY 10027
United States
Garud Iyengar
Columbia University - Department of Industrial Engineering and Operations Research (IEOR) ( email )
331 S.W. Mudd Building
500 West 120th Street
New York, NY 10027
United States
+1 212-854-4594 (Phone)
+1 212-854-8103 (Fax)
Chun Wang
Columbia University - Department of Industrial Engineering and Operations Research (IEOR) ( email )
331 S.W. Mudd Building
500 West 120th Street
New York, NY 10027
United States
Feedback to SSRN


Paper statistics
Abstract Views: 436
Downloads: 100
Download Rank: 155,408

© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollo3 in 0.453 seconds