Consumption, Portfolio Policies and Dynamic Equilibrium in the Presence of Preference for Ownership

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Consumption, Portfolio Policies and Dynamic Equilibrium in the Presence of Preference for Ownership

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Paul Ehling

Abstract

In this article we construct a model in which agents exhibit preference for ownership with respect to a durable (house). Ownership is modeled as a continuous function of debt service normalized by the price of the house. We study the utility optimization problem of an investor not endowed with the durable. In other words, the agent borrows against his future labor income in order to be able to purchase the house immediately. However, due to liquidity constraints, which prevent the poor agent from selling the fraction of his endowment that corresponds to the house price, i.e. shorting financial assets, the purchase of the house involves payments over long horizon. This work presents effects of preference for ownership on demands, interest rate and asset risk premium. The poor agent accumulates quickly wealth in the durable and postpones consumption. It is shown that the poor and liquidity constrained agent does not hold financial assets until the durable is completely acquired. We also show that the equilibrium interest rate depends, in particular, on the debt payments. Conditions under which preference for ownership decreases the equilibrium interest rate are provided. Nonseparabilities can cause a higher equity risk premium

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Paper provided by Econometric Society in its series Econometric Society 2004 North American Winter Meetings with number 311.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nawm04:311

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Find related papers by JEL classification:
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

This paper has been announced in the following NEP Reports:

NEP-ALL-2004-12-02 (All new papers)
NEP-FIN-2004-12-02 (Finance)

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