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Optimal portfolio choice with predictability in house prices and transaction costs

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  • Corradin, Stefano
  • Fillat, José L.
  • Vergara-Alert, Carles

Abstract

We generalize the classic Grossman and Laroque (1990) (GL) model of optimal portfolio choice with housing and transaction costs by introducing predictability in house prices. As in the GL model, agents only move to more expensive (cheaper) houses when their wealth-to-housing ratios reach an optimal lower (upper) boundary. However, in our model, these boundaries are time-varying and depend on the dynamics of the expected growth rate of house prices. We find that households moving to a more expensive house in periods of high expected growth in house prices have significantly lower ex-ante wealth-to-housing ratios than those moving in periods of low expected growth. We also find that the share of wealth invested in risky assets is lower during periods of high expected growth in house prices and that it is higher right before moving during periods of low growth. The main implications of the model are robust to tests using household level data from the PSID and SIPP surveys. JEL Classification: G11, D11, D91, C61

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Bibliographic Info

Paper provided by European Central Bank in its series Working Paper Series with number 1470.

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Date of creation: Sep 2012
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Handle: RePEc:ecb:ecbwps:20121470

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Keywords: Durable goods; housing returns predictability; optimal housing consumption and investment; transaction costs;

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References

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  1. 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.
  2. John Y. Campbell & Luis M. Viceira, 1998. "Consumption and Portfolio Decisions When Expected Returns Are Time Varying," Harvard Institute of Economic Research Working Papers 1835, Harvard - Institute of Economic Research.
  3. 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.).
  4. 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.
  5. Hamilton, James D., 1990. "Analysis of time series subject to changes in regime," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 39-70.
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Cited by:
  1. 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).
  2. Corradin, Stefano & Popov, Alexander, 2013. "House prices, home equity and entrepreneurships," Working Paper Series 1544, European Central Bank.
  3. Corradin, Stefano & Gropp, Reint & Huizinga, Harry & Laeven, Luc, 2011. "Who invests in home equity to exempt wealth from bankruptcy?," Working Paper Series 1337, European Central Bank.
  4. Corradin, Stefano, 2012. "Household leverage," Working Paper Series 1452, European Central Bank.
  5. Juan Carlos Hatchondo & Leonardo Martinez & Juan M. Sanchez, 2011. "Mortgage defaults," Working Paper 11-05, Federal Reserve Bank of Richmond.
  6. Corradin, Stefano & Fontana, Alessandro, 2013. "House price cycles in Europe," Working Paper Series 1613, European Central Bank.
  7. Stefano Corradin, 2013. "House Prices, Household Leverage, and Entrepreneurship," 2013 Meeting Papers 631, Society for Economic Dynamics.

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