PORTFOLIO SELECTION WITH TRANSACTION COSTS AND CAPITAL GAINS TAXES

LEI YAOTING

Publication

PORTFOLIO SELECTION WITH TRANSACTION COSTS AND CAPITAL GAINS TAXES

LEI YAOTING

Abstract

THIS THESIS CONCERNS THE MERTON PROBLEM WITH TRANSACTION COSTS AND CAPITAL GAINS TAXES. IN CONTRAST TO THE EXISTING LITERATURE, WE PROPOSE A MODEL CONSIDERING AN IMPORTANT MARKET FEATURE THAT TAXES ARE ONLY PAID AT THE END OF EACH CALENDAR YEAR. WE FIND THAT INVESTORS ARE INCLINED TO DEFER REALIZATION OF CAPITAL GAINS UNTIL THE BEGINNING OF THE NEXT CALENDAR YEAR. MOREOVER, THE PRESENCE OF TRANSACTION COSTS COULD LEAD INVESTORS TO DEFER REALIZATION OF CAPITAL LOSSES TO THE END OF EACH CALENDAR YEAR. ONE EXTENSION OF OUR MODEL IS ALSO DISCUSSED. WE INTRODUCE LABOR INCOME WITH NO-BORROWING CONSTRAINT. WE SHOW THAT THE INABILITY TO BORROW CAN SUBSTANTIALLY REDUCE CONSUMPTION AND INVESTMENT IN THE RISKY ASSET, AND CAN PROVIDE AN INCENTIVE TO TRADE MORE FREQUENTLY. WE FINALLY PROVIDE ASYMPTOTIC EXPANSIONS, AND OBTAIN AN EXPLICIT STRATEGY THAT CAN EFFECTIVELY APPROXIMATE THE OPTIMAL STRATEGY EVEN FOR RELATIVELY LARGE INTEREST RATE AND TAX RATE.