Heuristic Portfolio Trading Rules with Capital Gain Taxes

Marcel Fischer, Michael Gallmeyer

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Abstract

We study the out-of-sample performance of portfolio trading strategies used when an investor faces capital gain taxation and proportional transaction costs. Overlaying simple tax trading heuristics on trading strategies improves out-of-sample performance. For medium to large transaction costs, no trading strategy can outperform a 1/N trading strategy augmented with a tax heuristic, not even the most tax and transaction cost-efficient buy-and-hold strategy. Overall, the best strategy is 1/N augmented with a heuristic that allows for a fixed deviation in absolute portfolio weights. Our results thus show that the best trading strategies balance diversification considerations and tax considerations.
Original languageEnglish
JournalJournal of Financial Economics
Volume119
Issue number3
Pages (from-to)611–625
Number of pages15
ISSN0304-405X
DOIs
Publication statusPublished - Mar 2016

Keywords

  • Portfolio choice
  • Capital gain taxation
  • Limited use of capital losses
  • Heuristic trading rules

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