Two Birds, One Stone: Joint Timing of Returns and Capital Gains Taxes
Management Science, Accepted
56 Pages Posted: 23 Oct 2017 Last revised: 10 Mar 2019
Date Written: May 16, 2018
In asset return predictability, realized returns and future expected returns tend to move in opposite directions. This generates a tension between tax-timing and market-timing incentives. In this study, a portfolio choice problem in the presence of both return predictability and capital gains tax is examined. We characterize various features of the optimal trading strategy, and demonstrate that the optimal strategy helps mitigate the tension between market- and tax-timing. The calibrated model suggests that return predictability can significantly increase both the utility loss due to capital gains tax and the value of deferring capital gains realization. Overall, our results suggest that the nature of the asset return process can have important implications for the welfare effects of capital gains tax.
Keywords: Portfolio Choice, Return Predictability, Capital Gains Tax
JEL Classification: G11, H24, K34
Suggested Citation: Suggested Citation