Optimal dynamic tax evasion: A portfolio approach

Optimal investment and consumption in the market with jump risk and capital gains tax

“…We find that: (i) the optimal fractions of wealth invested in the concealed risky asset and the unconcealed risky asset are both time-invariable; (ii) jumps do not affect the optimal tax evasion strategy and the optimal weight in the unconcealed risky asset decreases in jump arrival intensity and the mean jump size; (iii) audits and punishments for tax evasion are effective ways to reduce an investor's behavior of tax evasion; (iv) the effects of jumps, audits and penalty intensity on the ratio of optimal consumption to wealth are critically dependent on the investor's degree of risk aversion. Moreover, different from [23], we find that high liquidity portfolio might be selected to hedge jump risk rather than as a sign of tax evasion. Therefore, high liquidity may be a misleading signal used to target audits.…”

“…In reality, due to the high rate of capital gains tax, an investor might conceal a portion of his investment to avoid paying capital gains tax. In a continuous-time optimal consumption and investment model, tax evasion is taken into account in [23], where the investor places his wealth in a riskless asset and a risky asset, and both returns will be taxed. Moreover, it is assumed that the investor could evade taxes on the revenue from the risky asset, but he could not on the revenue from the riskless asset.…”

“…Meanwhile, because taxation is subject to audit, once the behavior of evasion is detected, the investor will have to pay a fine, which is a function of the value of the concealed risky asset. However, [23] assumes that the price of the risky asset evolves continuously. As pointed out above, empirical evidence has repeatedly shown the existence of jumps in asset prices.…”

“…In this paper, we consider capital gains taxation. As in [23], we assume that (i) capital gains are taxed continuously and in a symmetric manner, that is, the investor pays tax if the change in asset price is positive and receives a refund if it is negative 1 ; and (ii) consumption will not be taxed. The tax rates levied on the payoff of the riskless asset and risky asset are denoted by τ G and τ , respectively.…”

“…θ * can be viewed as the tax-adjusted investment weight in the risky asset which includes non-concealed and concealed risky asset. In particular, when λ 1 = 0, the optimal consumption and portfolio strategy reduces to that in [23].…”