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Are Household Portfolios Efficient? an Analysis Conditional on Housing

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  • Pelizzon, Loriana
  • Weber, Guglielmo

Abstract

In this paper we argue that standard tests of portfolio efficiency are biased because they neglect the existence of illiquid wealth. In the case of household portfolios, the most important illiquid asset is housing: if housing stock adjustments are costly and therefore infrequent, we show how the dynamic optimization problem produces optimal portfolios in periods of no adjustment that are affected by housing price risk (through a hedge term). When the housing stock is not adjusted, we argue that tests for portfolio efficiency of financial assets must then be run conditionally upon housing wealth. In our application, we use Italian household portfolio data from SHIW 1998 and time series data on financial asset and housing stock returns to assess whether actual portfolios are efficient. We first consider purely financial portfolios and portfolios that also treat the housing stock as another asset. We then consider the consequences of treating the housing stock as given and test for efficiency in this framework. Our empirical results support the view that the presence of housing wealth plays an important role in determining whether portfolios chosen by home-owners are efficient.

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Bibliographic Info

Article provided by Cambridge University Press in its journal Journal of Financial and Quantitative Analysis.

Volume (Year): 43 (2008)
Issue (Month): 02 (June)
Pages: 401-431

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Handle: RePEc:cup:jfinqa:v:43:y:2008:i:02:p:401-431_00

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  1. Pelizzon, Loriana & Weber, Guglielmo, 2008. "Are Household Portfolios Efficient? an Analysis Conditional on Housing," Journal of Financial and Quantitative Analysis, Cambridge University Press, Cambridge University Press, vol. 43(02), pages 401-431, June.
  2. Grossman, Sanford J & Laroque, Guy, 1990. "Asset Pricing and Optimal Portfolio Choice in the Presence of Illiquid Durable Consumption Goods," Econometrica, Econometric Society, Econometric Society, vol. 58(1), pages 25-51, January.
  3. Ross, Stephen A & Zisler, Randall C, 1991. "Risk and Return in Real Estate," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 4(2), pages 175-90, June.
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  5. Yamashita, Takashi, 2003. "Owner-occupied housing and investment in stocks: an empirical test," Journal of Urban Economics, Elsevier, vol. 53(2), pages 220-237, March.
  6. David le Blanc & Christine Lagarenne, 2004. "Owner-Occupied Housing and the Composition of the Household Portfolio: The Case of France," The Journal of Real Estate Finance and Economics, Springer, Springer, vol. 29(3), pages 259-275, November.
  7. Goetzmann, W.N., 1990. "The Single Family Home In The Investment Portfolio," Papers fb-_90-15, Columbia - Graduate School of Business.
  8. John Heaton & Deborah Lucas, 2000. "Portfolio Choice and Asset Prices: The Importance of Entrepreneurial Risk," Journal of Finance, American Finance Association, American Finance Association, vol. 55(3), pages 1163-1198, 06.
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  10. Rui Yao, 2005. "Optimal Consumption and Portfolio Choices with Risky Housing and Borrowing Constraints," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 18(1), pages 197-239.
  11. Gourieroux, C. & Jouneau, F., 1999. "Econometrics of efficient fitted portfolios," Journal of Empirical Finance, Elsevier, Elsevier, vol. 6(1), pages 87-118, January.
  12. Jorion, Philippe, 1985. "International Portfolio Diversification with Estimation Risk," The Journal of Business, University of Chicago Press, vol. 58(3), pages 259-78, July.
  13. Marjorie Flavin & Shinobu Nakagawa, 2004. "A Model of Housing in the Presence of Adjustment Costs: A Structural Interpretation of Habit Persistence," NBER Working Papers 10458, National Bureau of Economic Research, Inc.
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  15. Guiso, Luigi & Jappelli, Tullio, 2000. "Household Portfolios in Italy," CEPR Discussion Papers, C.E.P.R. Discussion Papers 2549, C.E.P.R. Discussion Papers.
  16. Blake, David, 1996. "Efficiency, Risk Aversion and Portfolio Insurance: An Analysis of Financial Asset Portfolios Held by Investors in the United Kingdom," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 106(438), pages 1175-92, September.
  17. Henderson, J Vernon & Ioannides, Yannis M, 1983. "A Model of Housing Tenure Choice," American Economic Review, American Economic Association, vol. 73(1), pages 98-113, March.
  18. Cauley, Stephen D & Pavlov, Andrey D. & Schwartz, Eduardo S, 2005. "Homeownership as a Constraint on Asset Allocation," University of California at Los Angeles, Anderson Graduate School of Management, Anderson Graduate School of Management, UCLA qt7kg2p8nm, Anderson Graduate School of Management, UCLA.
  19. de Roon, Frans & Eichholtz, Piet & Koedijk, Kees, 2002. "The Portfolio Implications of Home Ownership," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3501, C.E.P.R. Discussion Papers.
  20. William N. Goetzmann & Roger G. Ibbotson, 1990. "The Performance Of Real Estate As An Asset Class," Journal of Applied Corporate Finance, Morgan Stanley, vol. 3(1), pages 65-76.
  21. Jobson, J. D. & Korkie, Bob, 1982. "Potential performance and tests of portfolio efficiency," Journal of Financial Economics, Elsevier, Elsevier, vol. 10(4), pages 433-466, December.
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