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Optimal Housing, Consumption, and Investment Decisions over the Life Cycle

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Author Info

  • Holger Kraft

    ()
    (Department of Finance, Goethe University Frankfurt am Main, 60323 Frankfurt am Main, Germany)

  • Claus Munk

    ()
    (School of Economics and Management and Department of Mathematical Sciences, Aarhus University, Aarhus DK-8000, Denmark)

Abstract

We derive explicit solutions to life-cycle utility maximization problems involving stock and bond investment, perishable consumption, and the rental and ownership of residential real estate. Prices of houses, stocks and bonds, and labor income are correlated. Because of a positive correlation between house prices and labor income, young individuals want little exposure to house price risk and tend to rent their home. Later in life the desired housing investment increases and will eventually reach and exceed the desired consumption, suggesting that the individual should buy his home--and either additional housing units (for renting out) or house price-linked financial assets. In the final years, preferences shift back to home rental. The derived strategies are still useful if housing positions are only reset infrequently. Our results suggest that markets for real estate investment trusts or other house price-linked contracts lead to nonnegligible welfare gains. This paper was accepted by Wei Xiong, finance.

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File URL: http://dx.doi.org/10.1287/mnsc.1110.1336
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Bibliographic Info

Article provided by INFORMS in its journal Management Science.

Volume (Year): 57 (2011)
Issue (Month): 6 (June)
Pages: 1025-1041

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Handle: RePEc:inm:ormnsc:v:57:y:2011:i:6:p:1025-1041

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Related research

Keywords: housing; labor income; portfolio choice; life-cycle decisions; REITs;

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Cited by:
  1. Marianna Brunetti & Elena Giarda & Costanza Torricelli, 2012. "Is Financial Fragility a Matter of Illiquidity? An Appraisal for Italian Households," CEIS Research Paper 242, Tor Vergata University, CEIS, revised 18 Jul 2012.
  2. Marekwica, Marcel & Stamos, Michael Z., 2010. "Optimal life cycle portfolio choice with housing market cycles," CFS Working Paper Series 2010/21, Center for Financial Studies (CFS).
  3. Fischer, Marcel & Kraft, Holger & Munk, Claus, 2013. "Asset allocation over the life cycle: How much do taxes matter?," Journal of Economic Dynamics and Control, Elsevier, vol. 37(11), pages 2217-2240.
  4. Torben Andersen & Mikkel Hermansen, 2014. "Durable consumption, saving and retirement," Journal of Population Economics, Springer, vol. 27(3), pages 825-840, July.
  5. Sheng Guo & William Hardin, 2014. "Wealth, Composition, Housing, Income and Consumption," The Journal of Real Estate Finance and Economics, Springer, vol. 48(2), pages 221-243, February.
  6. Marekwica, Marcel & Schaefer, Alexander & Sebastian, Steffen, 2013. "Life cycle asset allocation in the presence of housing and tax-deferred investing," Journal of Economic Dynamics and Control, Elsevier, vol. 37(6), pages 1110-1125.
  7. Zeng, Yan & Wu, Huiling & Lai, Yongzeng, 2013. "Optimal investment and consumption strategies with state-dependent utility functions and uncertain time-horizon," Economic Modelling, Elsevier, vol. 33(C), pages 462-470.

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