Large Capital Losses Research Articles

Optimal Tax-Timing Strategy in the Presence of Transaction Costs

Although prevalent in the financial markets, transaction costs have been largely ignored in the existing literature on the impact of capital gains tax. We develop a dynamic portfolio model that incorporates both transaction costs and annually payable capital gains taxes. We theoretically characterize and numerically compute the optimal tax-timing strategy. We show that our model can help explain the puzzle that even when investors face equal long-term/short-term capital gains tax rates, they may still defer realizing large capital losses and vary the realization strategies of capital gains and losses across months in a calendar year. In addition, our model provides some unique, empirically testable implications, such as (1) investors with capital losses may purchase a large number of shares without realizing any losses; and (2) investors' trading may increase with transaction costs.

Mexico

This paper discusses the findings and recommendations made in the Financial System Stability Assessment for Mexico. Mexico’s economic fundamentals are strong. The medium-term outlook for the Mexican economy foresees steady growth underpinned by strong macroeconomic policies, broad reform initiatives, and relatively strong balance sheets. Key risks are external and include a U.S. growth slowdown, lower oil prices, and volatility in global financial markets. The financial system is broadly resilient, notwithstanding some weaknesses under certain adverse shocks. The solvency and liquidity stress tests of the banking system indicate that it can withstand severe adverse macro-financial shocks despite large capital losses in some cases.

Wealth shocks, unemployment shocks and consumption in the wake of the Great Recession

Data from the 2009 Internet Survey of the Health and Retirement Study show that many US households experienced large capital losses in housing and financial wealth, and that 5% of respondents lost their job during the Great Recession. For every loss of 10% in housing and financial wealth, the estimated drop in household expenditure was about 0.56% and 0.9%, respectively. Those who became unemployed reduced spending by 10%. In line with predictions of standard inter-temporal choice models, households who perceived the stock market shock to be permanent adjusted spending much more than those who perceived the shock to be temporary.

Wealth Shocks, Unemployment Shocks and Consumption in the Wake of the Great Recession

We use data from the 2009 Internet Survey of the Health and Retirement Study to examine the consumption impact of wealth shocks and unemployment during the Great Recession in the US. We find that many households experienced large capital losses in housing and in their financial portfolios, and that a non-trivial fraction of respondents have lost their job. As a consequence of these shocks, many households reduced substantially their expenditures. We estimate that the marginal propensities to consume with respect to housing and financial wealth are 1 and 3.3 percentage points, respectively. In addition, those who became unemployed reduced spending by 10 percent. We also distinguish the effect of perceived transitory and permanent wealth shocks, splitting the sample between households who think that the stock market is likely to recover in a year’s time, and those who do not. In line with the predictions of standard models of intertemporal choice, we find that the latter group adjusted much more than the former its spending in response to financial wealth shocks.

Evaluation of Target-Date Glide Paths within Defined Contribution Plans

We present a simple methodology to support sponsors of defined contribution (DC) plans when evaluating the allocation to equity in target-date glide paths. Generally, the investment objective of a DC plan is twofold: accumulation of wealth prior to retirement and conversion of wealth to income during retirement. While wealth accumulation is fairly unambiguous, income generation depends on the intended horizon. In particular, sponsors face two primary considerations related to this horizon. The first is the ability of a glide path to generate lifetime income consistently over the course of retirement, while the second is the ability of the glide path to limit the risk of capital loss near and during retirement, which is particularly important for participants who withdraw their balances over a more moderate-term horizon. As one might expect, these considerations tend to be at odds with each other because while the long-term growth prospects of equity can enhance a portfolio's ability to generate lifetime income, its market volatility leads to greater variability in account balances, which can impair the ability to recover peak balances when withdrawals occur over shorter horizons. Thus, the challenge of glide path selection is really one of striking a compromise between these two competing goals. This compromise cannot be achieved via objective analysis alone and must also be informed by the subjective horizon and risk preferences of the sponsor acting as an agent for the plan participants. Two employers that each offer a DC plan with similar participant demographics and employee benefits may quite rationally select different glide paths because of different preferences. In our research, we find that higher-equity glide paths offer greater efficacy for lifetime income replacement, while lower-equity glide paths offer greater efficacy for stable account balances with lower risk of large capital losses. Directionally, these conclusions hold over a wide range of plan characteristics and assumptions, although the relative magnitude of the trade-off depends on characteristics unique to each plan.

Capital Gains Overhang and the Earnings Announcement Volume Premium

This study examined why stocks that experience high abnormal trading volume around earnings announcements earn high returns. The high returns of high-volume stocks appear to be associated with selling pressure that is independent of fundamentals and that comes from a subset of investors who base their selling decisions on the magnitude of unrealized capital gains or losses. Supplementary evidence based on account-level data from a U.S. brokerage firm suggests extra selling pressure for stocks with large capital losses around earnings announcements. These patterns also suggest that the conventional interpretation of the disposition effect may not hold for stocks with large, unrealized capital losses around earnings announcements.

Foreclosures and House Price Dynamics: A Quantitative Analysis of the Mortgage Crisis and the Foreclosure Prevention Policy

The authors construct a quantitative equilibrium model of the housing market in which an unanticipated increase in the supply of housing triggers default mortgages via its effect on house prices. The decline in house prices creates an incentive to increase the consumption of housing space, but leverage makes it costly for homeowners to sell their homes and buy bigger ones (they must absorb large capital losses). Instead, leveraged households find it advantageous to default and rent housing space. Since renters demand less housing space than homeowners, foreclosures are a negative force affecting house prices. The authors explore the possible effects of the government's foreclosure prevention policy in their model. They find that the policy can temporarily reduce foreclosures and shore up house prices.

Competing Risks in Hedge Fund Lifetimes

Recent evidence suggests that institutional investors wish to commit to hedge funds on a long-term basis, but they are worried that their investments may liquidate prematurely, leading to large capital losses. Providing them with rigorous models to predict liquidation is important, yet current studies of hedge fund lifetimes and mortality have treated all funds that exit the database as liquidated, when many of these funds are not liquidated. This has likely produced imprecise estimates of hedge fund lifetimes, attrition, and survivorship bias. This study aims to reconcile these important issues by applying a competing risks model to account for the different types of exits hedge funds can experience. By treating exit types separately, we avoid blurring the effect of predictor variables on survival because the variables are not attempting to predict a heterogeneous aggregation of exit types. Predictor variables whose value changes over time, such as returns or volatility, are modeled as time dependent variables rather than as fixed variables. This provides better warning signals to investors about possible fund liquidation, since the impact of the predictor variables is measured at every instant of hedge fund lifetimes, rather than during the last months of their life as is done in existing studies. Hedge funds that exit the database for reasons other than liquidation often have very good returns, so the direction of survivorship bias is not always evident. We avoid underestimating survivorship bias because funds that are not liquidated are not counted as dead. We find that separating exit types leads to estimates of annual attrition that are not as high as previously thought. The results of this study will allow investors to better estimate the expected lifetime of a hedge fund before allocating any money to it, and provide better warning signals to investors already committed to a hedge fund about possible fund liquidation, thereby helping all investors avoid the large capital losses that are often associated with liquidation.

Competing Risks for Hedge Fund Survival

Current studies of hedge fund lifetimes that apply survival analysis have treated all funds that exit the database as dead (liquidated), when in fact, many of these funds are not liquidated. Studies that treat all fund exits as liquidation, therefore, have likely produced faulty estimates of hedge fund lifetimes, attrition, and survivorship bias. This study aims to reconcile these important issues by applying a competing risks model to account for the different types of exits hedge funds can experience. By treating exit types separately, we avoid blurring the effect of predictor variables on survival because the variables are not attempting to predict a heterogeneous aggregation of exit types. Predictor variables whose value changes over time, such as returns or volatility, are modeled as time dependent variables rather than as fixed variables. This provides better warning signals to investors about possible fund liquidation, since the impact of the predictor variables is measured at every instant of hedge fund lifetimes, rather than during the last months of their life as is done in existing studies. Hedge funds that exit the database for reasons other than liquidation often have very good returns, so the direction of survivorship bias is not always evident. We avoid underestimating survivorship bias because funds that are not liquidated are not counted as dead. We find that separating exit types leads to estimates of annual attrition that are not as high as previously thought. The results of this study will allow investors to better estimate the expected lifetime of a hedge fund before allocating any money to it, and provide better warning signals to investors already committed to a hedge fund about possible fund liquidation, thereby helping all investors avoid the large capital losses that are often associated with liquidation.

Tenuous Property Rights: The Unraveling of Defined Benefit Pension Contracts in the United States

The private pension market in the United States has been almost completely transformed in less then 20 years. In the early 1980s, over 80 percent of all covered workers in the private sector had a classic defined benefit plan. In the year 2001, this share has fallen to less than 40 percent. In addition, approximately one in five defined benefit plans (weighted by workers) converted to a cash balance variety, which are defacto defined contribution plans. Some of this movement is attributable to economic trends favoring the kinds of firms and industries that traditionally favored the defined contribution format, but the evidence shows a strong and persistent reduction in preferences for the defined benefit variety. I argue that the underlying reason for this trend is the adoption of a new tax policy towards terminations in the early 1980s, one that permitted terminations for reversion, which were not attributable to financial difficulty of the sponsoring firm. This change eliminated the mechanism that bonded the implicit pension contract, creating the possibility of unilateral termination by one party under conditions not originally contemplated in the contract. The more firms that either terminated their plan or converted it to the cash balance variety, the more that workers still covered by defined benefit plans discounted the likelihood that their plan would survive. Since terminations and conversions confer large capital losses on workers, workers become leery of continuing to invest in the plan (in the form of foregone wages) unless it offers an extraordinary rate of return, which in turn affects the economics of offering the plan. The growing distrust of workers for firms holding up their end of the bargain creates the conditions that are ripe for the unraveling of the industry. Following these trends, pension economics now focuses on the ability of firms to use defined contribution plans to influence productivity in the firm. Other questions arise: Absent defined benefit plans, will firms lose their ability to influence retirement ages? Will lump sums from defined contribution plans deliver comparable retirement income to future cohorts? These issues thus far remain unresolved.

The tax-loss selling hypothesis, market liquidity, and price pressure around the turn-of-the-year

In this paper, we use intra-day data for all stocks listed on the ISSM and provide new and direct evidence consistent with the tax-loss selling hypothesis. We find that (a) there is abnormal selling pressure prior to the year-end for stocks that have experienced large capital losses in the current and prior years (b) investors delay realizing capital gain by postponing the sale of capital gain stocks until after the new year (c) there is a significant decrease in the average trade size for stocks with large capital losses before the year-end and for stocks with capital gains in the new year, which suggests that individuals, rather than institutional investors, are the major sellers around the year-end (d) the tax-loss selling hypothesis, and not firm size or share price, is the fundamental explanation for abnormal January returns. Further, small or low share priced firms with capital gains do not experience abnormal returns in January. However, conditional on capital losses, small or low share priced firms magnify the turn-of-the-year effect (e) On average, the increase in selling activity adversely affects market liquidity by increasing bid-ask spreads and reducing depths. (f) The tax-loss selling pressure not only causes the price to be at the bid at the year-end, it also temporarily depresses the equilibrium price indicating the short run demand curve is not perfectly elastic (g) the year-end buying activity suggests that large investors buy capital loss stocks prior to the year-end to take advantage of the temporarily depressed price and capital gain stocks after the new year to reinvest the proceeds of the tax-loss selling.

Singapore and the Asian Economic Crisis: An Assessment of Policy Responses

Singapore seems to have weathered the financial storm of East Asia better than most in the region. Yet it was not spared from contagion. Economic growth slowed from 7.8 per cent in 1997 to 1.5 per cent in 1998. The declining regional demand for Singapore's exports due to contraction in the crisis economies and loss of competitiveness in the face of competitive devaluations posed new challenges for Singapore which had to adopt policies to combat the crisis. This article examines the effects of proposed policies using a computable general equilibrium model. We find that the wage reduction and devaluation policies are more promising than domestic demand stimulation. I. Introduction Singapore seems to have weathered the financial storm of East Asia better than most in the region. Yet it was not spared from contagion. Economic growth slowed from 7.8 per cent in 1997 to 1.5 per cent in 1998. The crisis impacted different sectors unevenly. Sectors such as commerce, transport, tourism, and financial services, which have large regional exposures, were badly hit. The declining regional demand for exports and the challenge of maintaining international competitiveness despite competitive devaluations mean that Singapore had to adopt effective policy responses. This paper uses a computable general equilibrium (CGE) model to simulate the effects of policies adopted by Singapore. Section II is a brief discussion of the Asian crisis and its implications for Singapore. Section III reviews Singapore's policy responses to the crisis. Section IV presents the results. Section V concludes. II. The Asian Crisis and Its Implications for Singapore The Asian crisis began as an exchange rate crisis in Thailand and spread quickly to the Philippines and Indonesia, and then to Malaysia. This led to financial crises which, in turn, produced severe downturns in real economic activity in these, and other, countries. While a full discussion of the causes, propagation channels, and effects are beyond our scope,1 some points need to be made to show how, and to what extent, Singapore was caught up in the crisis. We focus on Thailand, the first domino. An overvalued exchange rate pegged to the US$,2 declining exports,3 and a growing current account deficit made Thailand vulnerable to a speculative exchange rate attack. The falling yen and an effective depreciation of about 10 per cent of the yuan4 contributed to reduced export competitiveness. The resulting devaluation triggered a financial crisis. Substantial capital inflows, about 6 per cent of GDP, had fuelled price bubbles in real estate and the stock market. Although these bubbles peaked at the end of 1993, by the end of 1997 share prices fell to about 29 per cent of their 1995 levels while the property company share index fell to 10 per cent of its 1995 level (Edison, Luangaram and Miller 1998, p. 4). In addition, relatively high domestic interest rates and the pegged exchange rate led to increases in foreign short-term borrowing5 that was largely unhedged. As the exchange rate fell, financial institutions suffered large capital losses as the value of their foreign denominated debt increased. These losses were magnified since most bank lending was backed by collateral, particularly real estate. Financial system solvency, already impaired, was further damaged as the value of the banks' collateral collapsed6 and non-performing loans increased. New domestic credit dried up, as did foreign credit with capital outflows of about 2 per cent of GDP. Otherwise viable firms were unable to finance working capital and new investment, leading to widespread bankruptcies and sharp declines in aggregate demand and real output.7 Financial system weaknesses (including implicit government guarantees against risk, inadequate monitoring, and supervision) prevented the devaluation from stimulating the economy as exporting firms were unable to take advantage of their increased price competitiveness (Montes and Popov 1999). …

Has deregulation decreased the risk of NYSE seat ownership?

It is well known that regulatory change led to large capital losses for owners of New York Stock Exchange seats. I show here that deregulation may also have led to a decrease in the risk of seat-holding.