Financial Engineering Seminar
January, 16, 2004 (Fri)
3:00 PM - 3:50 PM(8th period),
TBA
Tax Management Strategies with Multiple Risky Assets
This is joint work with Michael Gallmeyer, Carnegie Mellon University, and Ron Kaniel, Duke University.
Abstract
We study the consumption-portfolio problem of a capital gain taxed investor who has access to multiple risky stocks. Primary to our analysis is to understand how costly short selling influences portfolio choice with a shorting the box restriction. When the the stock return correlation is low and short sales prohibited, the optimal allocation for each stock is largely independent of the other stock's basis or allocation. At higher correlations, the optimal allocation of each stock is influenced by the basis and the position of the other stock. This leads to the investor potentially holding an undiversified equity portfolio. With short selling allowed, the trading strategy changes dramatically where the investor shorts equity under two different scenarios. The first, which is new in our analysis and identified as a trading flexibility strategy, is an ex ante way of minimizing future tax-induced trading costs. With this strategy, the investor shorts one of the stocks even when no stock has an embedded gain. The second incentive to short is an imperfect form of shorting the box used to ex-post reduce aggregate equity exposure. Given these two strategies to short, it is common for an unconstrained investor to short some equity while a constrained investor holds a positive investment in all stocks. A similar trading flexibility strategy is implicitly present if the investor can not short but is allowed to buy put options. Somewhat surprisingly, the benefit of trading separately in the two stocks for a short-sale constrained investor is not economically significant; while, on the other hand, the welfare benefit is significant for investors who can short at a low cost and for those who can trade in derivatives.
Download:
Paper.pdf