Optimal Portfolio Choice with Wash Sale Constraints

We analytically solve the portfolio choice problem in the presence of wash sale constraints in a two-period model with one risky asset. Our results show that wash sale constraints can heavily affect portfolio choice of investors with unrealized losses. The trading behavior of such investors is to a large extent driven by the desire to realize those losses, either immediately by sharply decreasing the holding of assets carrying unrealized losses, or indirectly by increasing such holdings in order to prepare for a decrease in a future period to earn the tax rebate payment. Our findings are robust to increasing the number of trading dates and introducing a second risky asset and a correlation structure.