IDEAS home Printed from
   My bibliography  Save this paper

Two Stock Portfolio Choice with Capital Gain Taxes and Short Sales


  • Michael Gallmeyer
  • Ron Kaniel
  • Stathis Tompaidis


In this paper, we study the consumption-portfolio problem of an investor who faces realized capital gain taxes in a two stock setting with short sales. The investor finances consumption and a time of death bequest by trading in a money market and two stocks that he can short sell subject to margin constraints and a shorting the box restriction. When the correlation between the two stocks is low, the investor's optimal strategy is similar to the case of one risky asset with the notable exceptions that the investor may optimally hold an undiversified equity position. At higher levels of correlation, tax trading costs lead to significantly different trading strategies. With short sale restrictions, it is common for the investor to hold an undiversified equity portfolio. With short selling, the trading strategy is dramatically different. The investor is induced to short equity under two different incentives. The first incentive is an imperfect form of shorting the box used to reduce the aggregate equity exposure while the second incentive is a trading flexibility strategy. Under the trading flexibility incentive, the investor shorts stock while holding a positive aggregate equity position even when the current portfolio has no embedded gains. By doing so, the investor uses the tax loss selling option embedded in the short position to offset gains in the larger long stock position when rebalancing. This trading flexibility incentive also leads to the investor holding less equity when older in contrast to the two stock case with no short sales and the previously studied one stock case.

Suggested Citation

  • Michael Gallmeyer & Ron Kaniel & Stathis Tompaidis, "undated". "Two Stock Portfolio Choice with Capital Gain Taxes and Short Sales," GSIA Working Papers 2001-E21, Carnegie Mellon University, Tepper School of Business.
  • Handle: RePEc:cmu:gsiawp:994085549

    Download full text from publisher

    File URL:
    Download Restriction: no

    References listed on IDEAS

    1. Eckhard Platen & Martin Schweizer, 1998. "On Feedback Effects from Hedging Derivatives," Mathematical Finance, Wiley Blackwell, vol. 8(1), pages 67-84.
    2. Cuoco, Domenico & Cvitanic, Jaksa, 1998. "Optimal consumption choices for a 'large' investor," Journal of Economic Dynamics and Control, Elsevier, vol. 22(3), pages 401-436, March.
    3. Robert A. Jarrow, 2008. "Derivative Security Markets, Market Manipulation, and Option Pricing Theory," World Scientific Book Chapters,in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 7, pages 131-151 World Scientific Publishing Co. Pte. Ltd..
    4. Hasbrouck, Joel, 1991. "The Summary Informativeness of Stock Trades: An Econometric Analysis," Review of Financial Studies, Society for Financial Studies, vol. 4(3), pages 571-595.
    5. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    Full references (including those not matched with items on IDEAS)

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:


    Access and download statistics


    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:cmu:gsiawp:994085549. 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: (Steve Spear). General contact details of provider: .

    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.