Portfolio Selection with Multiple Assets and Capital Gains Taxes

54 Pages Posted: 21 Jul 2001

See all articles by Lorenzo Garlappi

Lorenzo Garlappi

University of British Columbia (UBC) - Sauder School of Business

Vasant Naik

Lehman Brothers International, Europe

Joshua Slive

Bank of Canada

Date Written: July 2001

Abstract

We analyze the portfolio choice of an investor who can invest in tow risky assets (in addition to a riskless asset) and who is subject to taxes on realized capital gains. These taxes appear in the portfolio choice problem as a form of time-independent, endogenous transaction costs. Similar to the case of portfolio choice with transaction costs, the optimal strategy of the taxable investor contains a "no trade" region originating from the excercise of the option to defer capital gains taxes. This may lead an investor to hold a markedly undiversified portfolio, for reasonable parameter values. With multiple risky assets the investor is effectively holding a portfolio of tax-deferral options. The value of these options is considerable, in the range of 5-10% of the wealth of an investor with constant relative risk aversion. Such value is decreasing in the volatility and correlation of the assets and in the risk aversion. If the risky assets can be held only through a mutual fund, the investor incurs a cost due to the loss of flexibility whose magnitude is small when assets re positively correlated but can increase considerably as the correlation decreases.

Keywords: Capital Gains Taxes, Portfolio Choice

JEL Classification: G11, G12

Suggested Citation

Garlappi, Lorenzo and Naik, Vasant and Slive, Joshua, Portfolio Selection with Multiple Assets and Capital Gains Taxes (July 2001). Available at SSRN: https://ssrn.com/abstract=274939 or http://dx.doi.org/10.2139/ssrn.274939

Lorenzo Garlappi (Contact Author)

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada

Vasant Naik

Lehman Brothers International, Europe ( email )

25 Bank Street
30th Floor
London E14 5LE
England

Joshua Slive

Bank of Canada ( email )

234 Wellington Street
Ottawa, Ontario K1A 0G9
Canada

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