4,911 research outputs found
Modeling continuous-time financial markets with capital gains taxes
We formulate a model of continuous-time financial market consisting of a bank account with constant interest rate and one risky asset subject to capital gains taxes. We consider the problem of maximizing expected utility from future consumption in infinite horizon. This is the continuous-time version of the model introduced by Dammon, Spatt and Zhang [11]. The taxation rule is linear so that it allows for tax credits when capital gains losses are experienced. In this context, wash sales are optimal. Our main contribution is to derive lower and upper bounds on the value function in terms of the corresponding value in a tax-free and frictionless model. While the upper bound corresponds to the value function in a tax-free model, the lower bound is a consequence of wash sales. As an important implication of these bounds, we derive an explicit first order expansion of our value function for small interest rate and tax rate coefficients. In order to examine the accuracy of this approximation, we provide a characterization of the value function in terms of the associated dynamic programming equation, and we suggest a numerical approximation scheme based on finite differences and the Howard algorithm. The numerical results show that the first order Taylor expansion is reasonably accurate for reasonable market data
Combining Alpha Streams with Costs
We discuss investment allocation to multiple alpha streams traded on the same
execution platform with internal crossing of trades and point out differences
with allocating investment when alpha streams are traded on separate execution
platforms with no crossing. First, in the latter case allocation weights are
non-negative, while in the former case they can be negative. Second, the
effects of both linear and nonlinear (impact) costs are different in these two
cases due to turnover reduction when the trades are crossed. Third, the
turnover reduction depends on the universe of traded alpha streams, so if some
alpha streams have zero allocations, turnover reduction needs to be recomputed,
hence an iterative procedure. We discuss an algorithm for finding allocation
weights with crossing and linear costs. We also discuss a simple approximation
when nonlinear costs are added, making the allocation problem tractable while
still capturing nonlinear portfolio capacity bound effects. We also define
"regression with costs" as a limit of optimization with costs, useful in
often-occurring cases with singular alpha covariance matrix.Comment: 21 pages; minor misprints corrected; to appear in The Journal of Ris
Notes on Alpha Stream Optimization
In these notes we discuss investment allocation to multiple alpha streams
traded on the same execution platform, including when trades are crossed
internally resulting in turnover reduction. We discuss approaches to alpha
weight optimization where one maximizes P&L subject to bounds on volatility (or
Sharpe ratio). The presence of negative alpha weights, which are allowed when
alpha streams are traded on the same execution platform, complicates the
optimization problem. By using factor model approach to alpha covariance
matrix, the original optimization problem can be viewed as a 1-dimensional root
searching problem plus an optimization problem that requires a finite number of
iterations. We discuss this approach without costs and with linear costs, and
also with nonlinear costs in a certain approximation, which makes the
allocation problem tractable without forgoing nonlinear portfolio capacity
bound effects.Comment: 42 pages; clarifying remarks added, minor misprints corrected; to
appear in The Journal of Investment Strategie
The dynamic programming equation for the problem of optimal investment under capital gains taxes
This paper considers an extension of the Merton optimal investment
problem to the case where the risky asset is subject to
transaction costs and capital gains taxes. We derive the dynamic
programming equation in the sense of constrained viscosity
solutions. We next introduce a family of functions, which converges to our value
function uniformly on compact subsets, and which is characterized
as the unique constrained viscosity solution of an approximation
of our dynamic programming equation. In particular, this result
justifies the numerical results reported in the accompanying paper by the authors
Style rotation and performance persistence of mutual funds
Most academic studies on performance persistence in monthly mutual fund returns do not find evidence for timing skills of fund managers. Furthermore, realized returns are undoubtedly driven by the investment style of a fund. We propose a new holdings-based measure of style rotation to investigate the relation between performance persistence and changes in style. For a large sample of U.S. domestic equity mutual funds we find that top and bottom performing decile portfolios, sorted on past one-year returns and risk djusted excess performance from a 4-factor model, are subject to a higher degree of style rotation than middle deciles. Style inconsistent funds with high values for the style rotation measure in turn exhibit less persistence in decile rankings over subsequent years than style consistent funds. Hence, it is important for delegated portfolio management to consider style rotation when selecting managers based on past performance.mutual fund, performance persistence, style rotation.
- …