Portfolio Tax Trading with Carry-Over Losses
78 Pages Posted: 4 Mar 2008 Last revised: 25 Jun 2015
Date Written: June 2015
We study portfolio choice with multiple stocks and capital gain taxation assuming that capital losses can only offset current or future realized capital gains. We show through backtesting, using empirical distributions, that optimal equity holdings over an extended period are significantly lower on average than benchmark holdings suggested in the literature. Using Value and Growth or Small and Large portfolios, the backtests show that allocations remain persistently under-diversified. Carry-over losses have large economic significance since they can dramatically shrink the no-trade region. Finally, the backtested economic cost of incorrectly modeling capital losses is at least 8 percent of lifetime wealth.
Keywords: portfolio choice, capital gain taxation, limited use of capital losses, carry-over losses
JEL Classification: G11, H20
Suggested Citation: Suggested Citation