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Optimal portfolio choice with predictability in house prices and transaction costs

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  • Corradin, Stefano

    (European Central Bank)

  • Fillat, Jose L.

    (Federal Reserve Bank of Boston)

  • Vergara, Carles

    ()
    (IESE Business School)

Abstract

Are housing returns predictable? If so, do households take them into account when making their housing consumption and portfolio decisions? We document the existence of housing return predictability in the U.S. at the aggregate, census region, and state level. We study a portfolio choice model in which housing returns are predictable and adjustment costs must be paid when a house is purchased or sold. We show that two state variables affect the agent's decisions: 1) her wealth-to-housing ratio; and 2) the time-varying expected growth rate of house prices. The agent buys (sells) her housing assets only when the wealth-to-housing ratio reaches an optimal upper (lower) bound. These bounds are time-varying and depend on the expected growth rate of house prices. Finally, we use household level data from the PSID and SIPP surveys to test and support the model's main implications.

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Bibliographic Info

Paper provided by IESE Business School in its series IESE Research Papers with number D/948.

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Length: 96 pages
Date of creation: 03 Feb 2012
Date of revision:
Handle: RePEc:ebg:iesewp:d-0948

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Postal: IESE Business School, Av Pearson 21, 08034 Barcelona, SPAIN
Web page: http://www.iese.edu/
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Keywords: Portfolio choice; predictability; house prices; household finance;

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References

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  1. John Y. Campbell & Luis M. Viceira, 1999. "Consumption And Portfolio Decisions When Expected Returns Are Time Varying," The Quarterly Journal of Economics, MIT Press, vol. 114(2), pages 433-495, May.
  2. Damgaard, Anders & Fuglsbjerg, Brian & Munk, Claus, 2003. "Optimal consumption and investment strategies with a perishable and an indivisible durable consumption good," Journal of Economic Dynamics and Control, Elsevier, vol. 28(2), pages 209-253, November.
  3. Henkel, Sam James & Martin, J. Spencer & Nardari, Federico, 2011. "Time-varying short-horizon predictability," Journal of Financial Economics, Elsevier, vol. 99(3), pages 560-580, March.
  4. Hamilton, James D., 1990. "Analysis of time series subject to changes in regime," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 39-70.
  5. 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.).
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Cited by:
  1. Corradin, Stefano & Popov, Alexander, 2013. "House prices, home equity and entrepreneurships," Working Paper Series 1544, European Central Bank.
  2. Corradin, Stefano & Gropp, Reint & Huizinga, Harry & Laeven, Luc, 2010. "Who Invests in Home Equity to Exempt Wealth from Bankruptcy?," CEPR Discussion Papers 8097, C.E.P.R. Discussion Papers.
  3. Juan Carlos Hatchondo & Leonardo Martinez & Juan M. Sánchez, 2011. "Mortgage defaults," Working Papers 2011-019, Federal Reserve Bank of St. Louis.
  4. Stefano Corradin, 2013. "House Prices, Household Leverage, and Entrepreneurship," 2013 Meeting Papers 631, Society for Economic Dynamics.
  5. 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).
  6. Corradin, Stefano & Fontana, Alessandro, 2013. "House price cycles in Europe," Working Paper Series 1613, European Central Bank.
  7. European Central Bank & Stefano Corradin, 2009. "Household Leverage," 2009 Meeting Papers 906, Society for Economic Dynamics.

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