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Owner-Occupied Housing and the Composition of the Household Portfolio over the Life Cycle

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  • Flavin, Marjorie
  • Yamashita, Takashi
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    Abstract

    The paper studies the impact of the portfolio constraint imposed by the consumption demand for housing (the "housing constraint") on the household's optimal holdings of financial assets. Since the ratio of housing to net worth declines as the household accumulates wealth, the housing constraint induces a life-cycle pattern in the portfolio shares of stocks and bonds. For reasonable degrees of risk aversion, the changes in portfolio composition over the life-cycle can be dramatic. For example, for a coefficient of relative risk aversion of 3, the ratio of stocks to net worth in the optimal portfolio is .09 for the youngest households (ages 18-30) and .60 for the oldest (age 70 and over). Using data from the PSID on home values to construct household level panel data on the real after-tax return to owner-occupied housing, as well as data on the returns to financial assets, the paper estimates the vector of expected returns and the covariance matrix for the set of assets consisting of housing, mortgages, stocks, Treasury bonds, and T-bills. Numerical methods are used to calculate the mean-variance efficient frontier, conditional on different values of the housing constraint, and the optimal portfolios associated with different levels of relative risk aversion.

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    Bibliographic Info

    Paper provided by Department of Economics, UC San Diego in its series University of California at San Diego, Economics Working Paper Series with number qt89x293v9.

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    Date of creation: 01 Jan 1998
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    Handle: RePEc:cdl:ucsdec:qt89x293v9

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    Keywords: mean-variance efficiency; portfolio management;

    References

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    1. James M. Poterba & Andrew A. Samwick, 1997. "Household Portfolio Allocation Over the Life Cycle," NBER Working Papers 6185, National Bureau of Economic Research, Inc.
    2. Sharpe, William F., 1990. "Capital Asset Prices With and Without Negative Holding," Nobel Prize in Economics documents 1990-3, Nobel Prize Committee.
    3. 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.
    4. Hilary W. Hoynes & Daniel L. McFadden, 1996. "The Impact of Demographics on Housing and Nonhousing Wealth in the United States," NBER Chapters, in: The Economic Effects of Aging in the United States and Japan, pages 153-194 National Bureau of Economic Research, Inc.
    5. 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, vol. 106(438), pages 1175-92, September.
    6. Bodie, Zvi & Merton, Robert C. & Samuelson, William F., 1992. "Labor supply flexibility and portfolio choice in a life cycle model," Journal of Economic Dynamics and Control, Elsevier, vol. 16(3-4), pages 427-449.
    7. Robert S. Pindyck, 1986. "Risk Aversion and Determinants of Stock Market Behavior," NBER Working Papers 1921, National Bureau of Economic Research, Inc.
    8. Ross, Stephen A & Zisler, Randall C, 1991. "Risk and Return in Real Estate," The Journal of Real Estate Finance and Economics, Springer, vol. 4(2), pages 175-90, June.
    9. Grossman, Sanford J & Shiller, Robert J, 1981. "The Determinants of the Variability of Stock Market Prices," American Economic Review, American Economic Association, vol. 71(2), pages 222-27, May.
    10. Goetzmann, W.N., 1990. "The Single Family Home In The Investment Portfolio," Papers fb-_90-15, Columbia - Graduate School of Business.
    11. Levy, H & Markowtiz, H M, 1979. "Approximating Expected Utility by a Function of Mean and Variance," American Economic Review, American Economic Association, vol. 69(3), pages 308-17, June.
    12. Engelhardt, Gary V., 1996. "House prices and home owner saving behavior," Regional Science and Urban Economics, Elsevier, vol. 26(3-4), pages 313-336, June.
    13. Brueckner, Jan K, 1997. "Consumption and Investment Motives and the Portfolio Choices of Homeowners," The Journal of Real Estate Finance and Economics, Springer, vol. 15(2), pages 159-80, October.
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    Cited by:
    1. Englund, Peter & Hwang, Min & Quigley, John M., 2001. "Hedging Housing Risk," SIFR Research Report Series 2, Institute for Financial Research.
    2. Ji, Tingting, 2004. "Essays on consumer portfolio choice and credit risk," MPRA Paper 3161, University Library of Munich, Germany.
    3. Fuad Hasanov & Douglas Dacy, 2005. "Measuring and Analyzing Returns on Aggregate Residential Housing," Finance 0510005, EconWPA.
    4. Sebastian Barnes & Garry Young, 2003. "The rise in US household debt: assessing its causes and sustainability," Bank of England working papers 206, Bank of England.
    5. Perraudin, William R. M. & Sorensen, Bent E., 2000. "The demand for risky assets: Sample selection and household portfolios," Journal of Econometrics, Elsevier, vol. 97(1), pages 117-144, July.
    6. Andersson, Björn, 2001. "Portfolio Allocation over the Life Cycle: Evidence from Swedish Household Data," Working Paper Series 2001:4, Uppsala University, Department of Economics.
    7. Joseph Nichols, 2004. "A Life-cycle Model with Housing, Portfolio Allocation, and Mortgage Financing," Econometric Society 2004 North American Winter Meetings 205, Econometric Society.
    8. Robert F. Martin, 2003. "Consumption, durable goods, and transaction costs," International Finance Discussion Papers 756, Board of Governors of the Federal Reserve System (U.S.).
    9. Carol Bertaut & Martha Starr-McCluer, 2000. "Household portfolios in the United States," Finance and Economics Discussion Series 2000-26, Board of Governors of the Federal Reserve System (U.S.).

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