Volume 30, Issue 3 (Autumn 2025)
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Faghihi M. (2025). Financial Markets Frictions and Tax Code Convexity Implications for Dynamic Risk Budget. JEPR. 30(3),
URL: http://eprj.ir/article-1-2393-en.html
URL: http://eprj.ir/article-1-2393-en.html
Assistant Professor, Department of Economics, Allameh Tabatabaee University, Tehran, Iran , mir30kas@gmail.com
Abstract: (364 Views)
Risk management involved in the activities of economic enterprises, especially financial institutions, and its critical role for long-term survival and dynamic compliance with the requirements and limitations of economic capital resources available to them, has raised serious concerns about risk budgeting among researchers and managers. Accordingly, the dynamic risk budgeting approach in a parsimonious analytical setting including necessarily the relevant real-world characteristic and determining elements constitutes the focal point of this study. Therefore, by the use of a time-consistent continuous-time dynamic stochastic partial equilibrium model for economic agents’ decision making, the implications of the financial market frictions and the tax code convexity for dynamic risk budget adjustments and optimal hedging strategies have been investigated. It is shown how market frictions and such distortionary policy interventions can, under certain conditions, have distributional effects on hedged returns and thereby dynamic risk budgeting. How market frictions and tax code convexity interact in the context of risk budgeting dynamics and their policy and regulatory implications are also analyzed. The implications of the transaction costs entailed each case have also been explored in the quantitative simulation.
Keywords: Risk Budgeting, Financial Market Frictions, Tax Code Convexity, Conditional Value at Risk, Hedging Costs, Transaction Costs
Type of Study: Research |
Subject:
financial economics
Received: Aug 15 2025 | Accepted: Dec 30 2025 | ePublished: May 23 2026
Received: Aug 15 2025 | Accepted: Dec 30 2025 | ePublished: May 23 2026
References
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30. Ai, H., Li, J. E., Li, K., & Schlag, C. (2020). The collateralizability premium. The Review of Financial Studies, 33(12), 5821-5855. [DOI:10.1093/rfs/hhaa063]
31. Becker, M., & Löffler, A. (2024). Arbitrage and non-linear taxes. Review of Managerial Science, 18(12), 3487-3514. [DOI:10.1007/s11846-023-00721-1]
32. Campbell, R., Huisman, R., & Koedijk, K. (2001). Optimal portfolio selection in a Value-at-Risk framework. Journal of Banking & Finance, 25(9), 1789-1804. [DOI:10.1016/S0378-4266(00)00160-6]
33. Cetingoz, A. R., Fermanian, J. D., & Guéant, O. (2022). Stochastic Algorithms for Advanced Risk Budgeting (No. hal-03857964). HAL.
34. Dou, W. W., Fang, X., Lo, A. W., & Uhlig, H. (2023). Macro-finance models with nonlinear dynamics. Annual Review of Financial Economics, 15(1), 407-432. [DOI:10.1146/annurev-financial-110921-112053]
35. Graham, J. R., & Smith, C. W. (1999). Tax incentives to hedge. The Journal of Finance, 54(6), 2241-2262. [DOI:10.1111/0022-1082.00187]
36. Horan, S. M. (2007). Applying after-tax asset allocation. The Journal of Wealth Management, 10(2), 84. [DOI:10.3905/jwm.2007.690951]
37. Lei, A. C., Yick, M. H., & Lam, K. S. (2013). Does tax convexity matter for risk? A dynamic study of tax asymmetry and equity beta. Review of Quantitative Finance and Accounting, 41(1), 131-147. [DOI:10.1007/s11156-012-0303-2]
38. Lei, A. C., Yick, M. H., & Lam, K. S. (2014). The effects of tax convexity on default and investment decisions. Applied Economics, 46(11), 1267-1278. [DOI:10.1080/00036846.2013.870653]
39. Leibowitz, M. L., & Kogelman, S. (1991). Asset allocation under shortfall constraints. Risk, 3(2), 5. [DOI:10.3905/jpm.1991.409309]
40. Maillard S, Roncalli T, Teıletche J (2010). On the properties of equally weighted risk contribution portfolios.The Journal of Portfolio Management 36(4):60-70. [DOI:10.3905/jpm.2010.36.4.060]
41. Merton, R. (1969). Lifetime portfolio selection under uncertainty: the continuous-time case. Review of Economics and Statistics 51 (3), 247-25 [DOI:10.2307/1926560]
42. Merton, R. (1971). Optimum consumption and portfolio rules in a continuous-time model. Journal of Economic Theory 3, 373-413. (Cited on page 2) [DOI:10.1016/0022-0531(71)90038-X]
43. Mossin, J. (1968). Optimal multi-period portfolio policies. Journal of Business 41 (2), 215-229. [DOI:10.1086/295078]
44. Pesenti, S. M., Jaimungal, S., Saporito, Y. F., & Targino, R. S. (2025). Risk budgeting allocation for dynamic risk measures. Operations Research, 73(3), 1208-1229., Cornel University, arXiv:2305.11319 and SSRN.4452742 [DOI:10.1287/opre.2023.0299]
45. Qian E (2005). Risk parity portfolios: Efficient portfolios through true diversification. Panagora Asset Management.
46. Qian E (2011). Risk parity and diversification. The Journal of Investing 20(1):119-127 [DOI:10.3905/joi.2011.20.1.119]
47. Reichenstein, W. (2001). Rethinking the Family's Asset Allocation. Journal of Financial Planning, 14(5).
48. Richard, J. C., & Roncalli, T. (2019). Constrained risk budgeting portfolios: Theory, algorithms, applications & puzzles. arXiv preprint arXiv:1902.05710. [DOI:10.2139/ssrn.3331184]
49. Roncalli, T. (2013). Introduction to risk parity and budgeting. CRC press. [DOI:10.2139/ssrn.2272973]
50. Roncalli, T., & Weisang, G. (2016). Risk parity portfolios with risk factors. Quantitative Finance, 16(3), 377-388. [DOI:10.1080/14697688.2015.1046907]
51. Roy, A. D. (1952). Safety first and the holding of assets. Econometrica: Journal of the econometric society, 431-449. [DOI:10.2307/1907413]
52. Samuelson, P. (1969). Lifetime portfolio selection by dynamic stochastic programming. Review of Economics and Statistics 51, 239-46 [DOI:10.2307/1926559]
53. Sarkar, S. (2008). Can tax convexity be ignored in corporate financing decisions?. Journal of Banking & Finance, 32(7), 1310-1321. [DOI:10.1016/j.jbankfin.2007.11.007]
54. Smith, C. W., & Stulz, R. M. (1985). The determinants of firms' hedging policies. Journal of financial and quantitative analysis, 20(4), 391-405. [DOI:10.2307/2330757]
55. Strassberger, M. (2006). Capital Requirement, Portfolio Risk Insurance, and Dynamic Risk Budgeting. Investment Management and Financial Innovations [DOI:10.2139/ssrn.672302]
56. Unger, A. (2014). The use of risk budgets in portfolio optimization. Springer. [DOI:10.1007/978-3-658-07259-9]
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