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

See all articles by Yaoting Lei

Yaoting Lei

Nanchang University

Ya LI

The Open University of Hong Kong

Jing Xu

Renmin University of China - School of Finance

Date Written: May 16, 2018

Abstract

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

Lei, Yaoting and LI, Ya and Xu, Jing, Two Birds, One Stone: Joint Timing of Returns and Capital Gains Taxes (May 16, 2018). Management Science, Accepted. Available at SSRN: https://ssrn.com/abstract=3057371 or http://dx.doi.org/10.2139/ssrn.3057371

Yaoting Lei

Nanchang University ( email )

999 Xuefu Avenue
Hong Gu Tan New District
Nanchang, Jiangxi 330031
China

Ya LI

The Open University of Hong Kong ( email )

30 Good Shepherd Street, Ho Man Tin
Hong Kong

Jing Xu (Contact Author)

Renmin University of China - School of Finance ( email )

59 Zhongguancun Street
Beijing, 100872
China

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