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How the Closure of a U.S. Tax Loophole May Affect Investor Portfolios

Author

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  • Christoph Frei

    (Department of Mathematical and Statistical Sciences, University of Alberta, Edmonton, AB T6G 2G1, Canada)

  • Liam Welsh

    (Department of Statistical Sciences, University of Toronto, Toronto, ON M5G 1Z5, Canada)

Abstract

In the United States, exchange-traded funds can defer capital gains taxes of their investors by taking advantage of a legal loophole. To quantify the impact of this tax loophole on investor portfolios, we study a rank-dependent expected utility model. We develop an approximation formula for the sensitivity of the optimal investment strategy with respect to changes in the expected asset returns. By applying this approximation formula, we are able to quantitatively estimate how much investor portfolios may change depending on the investment horizon if the tax loophole is closed.

Suggested Citation

  • Christoph Frei & Liam Welsh, 2022. "How the Closure of a U.S. Tax Loophole May Affect Investor Portfolios," JRFM, MDPI, vol. 15(5), pages 1-10, May.
    • Handle: RePEc:gam:jjrfmx:v:15:y:2022:i:5:p:209-:d:808379
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    References listed on IDEAS

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    3. Valery Polkovnichenko & Kelsey D. Wei & Feng Zhao, 2019. "Cautious Risk Takers: Investor Preferences and Demand for Active Management," Journal of Finance, American Finance Association, vol. 74(2), pages 1025-1075, April.
    4. Ying Hu & Hanqing Jin & Xun Yu Zhou, 2021. "Consistent Investment of Sophisticated Rank-Dependent Utility Agents in Continuous Time," Post-Print hal-02624308, HAL.
    5. Chamberlain, Gary, 1983. "A characterization of the distributions that imply mean--Variance utility functions," Journal of Economic Theory, Elsevier, vol. 29(1), pages 185-201, February.
    6. Drazen Prelec, 1998. "The Probability Weighting Function," Econometrica, Econometric Society, vol. 66(3), pages 497-528, May.
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