The researchers are analyzing models of portfolio diversification with multiple risky assets in which the selling decisions of investors are influenced by the presence of capital gains taxes. Investors currently have little guidance for trading off the benefits of portfolio diversification and the payment of capital gains taxes. A central problem investors confront, however, is determining their asset allocation in light of alternative ways to adjust risk exposures given the structure of capital gains taxes.
In two earlier papers, also supported by the Research Grant Program, the researchers demonstrated that an investor's optimal asset allocation in equities was a function of the investor’s initial asset accumulation, embedded capital gains in equities, and age. The differential tax treatment afforded long-term capital gains was an important factor in this analysis, and led to the conclusion that equity exposure might actually increase with age in the presence of a bequest motive. By extending this analysis to also include a tax-deferred account, the researchers also examined the extent to which tax-deferred investing influences asset allocation within the investor's taxable account and how this allocation interacts with the optimal allocation within the tax-deferred account.
These studies are part of a broader research program to develop models of how investors should allocate their exposures to different assets in the face of a realistic tax environment. In developing models of a risk-averse investor's optimal asset allocation with capital gains taxes, an important next step is to consider multiple risky assets and how a portfolio of risky assets influences the investor's optimal asset allocation and realization decisions.
