IDEAS home Printed from https://ideas.repec.org/a/taf/apmtfi/v18y2011i4p291-329.html
   My bibliography  Save this article

Optimal Asset Allocation for Passive Investing with Capital Loss Harvesting

Author

Listed:
  • Daniel Ostrov
  • Thomas Wong

Abstract

This article examines how to quantify and optimally utilize the beneficial effect that capital loss harvesting generates in a taxable portfolio. We explicitly determine the optimal initial asset allocation for an investor who follows the continuous time dynamic trading strategy of Constantinides (1983). This strategy sells and re-buys all stocks with losses, but is otherwise passive. Our model allows the use of the stock position's full purchase history for computing the cost basis. The method can also be used to rebalance at later times. For portfolios with one stock position and cash, the probability density function for the portfolio's state corresponds to the solution of a 3-space + 1-time dimensional partial differential equation (PDE) with an oblique reflecting boundary condition. Extensions of this PDE, including to the case of multiple correlated stocks, are also presented. We detail a numerical algorithm for the PDE in the single stock case. The algorithm shows the significant effect capital loss harvesting can have on the optimal stock allocation, and it also allows us to compute the expected additional return that capital loss harvesting generates. Our PDE-based algorithm, compared with Monte Carlo methods, is shown to generate much more precise results in a fraction of the time. Finally, we employ Monte Carlo methods to approximate the impact of many of our model's assumptions.

Suggested Citation

  • Daniel Ostrov & Thomas Wong, 2011. "Optimal Asset Allocation for Passive Investing with Capital Loss Harvesting," Applied Mathematical Finance, Taylor & Francis Journals, vol. 18(4), pages 291-329.
  • Handle: RePEc:taf:apmtfi:v:18:y:2011:i:4:p:291-329
    DOI: 10.1080/1350486X.2010.513499
    as

    Download full text from publisher

    File URL: http://www.tandfonline.com/doi/abs/10.1080/1350486X.2010.513499
    Download Restriction: Access to full text is restricted to subscribers.

    As the access to this document is restricted, you may want to search for a different version of it.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:taf:apmtfi:v:18:y:2011:i:4:p:291-329. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Chris Longhurst). General contact details of provider: http://www.tandfonline.com/RAMF20 .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.