Portfolio Tax Trading with Carryover Losses

We study portfolio choice with multiple stocks and capital gains taxation, assuming that capital losses can only offset current or future realized capital gains. We show, through backtesting using empirical distributions, that optimal equity holdings over an extended period are significantly lower on average than benchmark holdings suggested in the literature. Using value and growth or small and large portfolios, the backtests show that allocations remain persistently underdiversified. Carryover losses have large economic significance since they can dramatically shrink the no-trade region. Finally, the backtested economic cost of incorrectly modeling capital losses is at least 8% of lifetime wealth. The Internet appendix is available at https://doi.org/10.1287/mnsc.2017.2733 . This paper was accepted by Neng Wang, finance.