Optimal Asset Location and Allocation with Taxable and Tax-Deferred Investing

47 Pages Posted: 2 Sep 2001

See all articles by Robert M. Dammon

Robert M. Dammon

Carnegie Mellon University

Harold H. Zhang

University of Texas at Dallas - Naveen Jindal School of Management; China Academy of Financial Research (CAFR)

Chester S. Spatt

Carnegie Mellon University - David A. Tepper School of Business

Date Written: August 23, 2001

Abstract

We investigate the optimal intertemporal asset allocation and location decisions for an investor with both taxable and tax-deferred investment opportunities. With unrestricted borrowing opportunities, the investor optimally allocates his entire tax-deferred wealth to taxable bonds and combines either borrowing or lending with investment in equity in the taxable account to achieve his optimal overall risk exposure. When the investor is prohibited from borrowing, the optimal asset allocation in his tax-deferred account may consist of both bonds and stocks, but only if the wealth in his taxable account is allocated entirely to equity. The preference for holding taxable bonds in the tax-deferred account and equity in the taxable account reflects the higher ordinary income on bonds and the tax avoidance strategies available on equity. The effect of liquidity shocks on the optimal asset location policy is also examined. Our results are in striking contrast to the asset location choices observed in practice.

Keywords: Taxable and tax-deferred investing, Asset location, Asset allocation

JEL Classification: G11, G12, H20

Suggested Citation

Dammon, Robert M. and Zhang, Harold Huibing and Spatt, Chester S., Optimal Asset Location and Allocation with Taxable and Tax-Deferred Investing (August 23, 2001). Available at SSRN: https://ssrn.com/abstract=281681 or http://dx.doi.org/10.2139/ssrn.281681

Robert M. Dammon

Carnegie Mellon University ( email )

GSIA
Pittsburgh, PA 15213
United States
412-268-3696 (Phone)

Harold Huibing Zhang (Contact Author)

University of Texas at Dallas - Naveen Jindal School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States

China Academy of Financial Research (CAFR)

1954 Huashan Road
Shanghai P.R.China, 200030
China

Chester S. Spatt

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States
412-268-8834 (Phone)
412-268-6689 (Fax)

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