IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this article

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

  • 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)

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.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://dx.doi.org/10.1287/mnsc.1110.1336
Download Restriction: no

Article provided by INFORMS in its journal Management Science.

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

as
in new window

Handle: RePEc:inm:ormnsc:v:57:y:2011:i:6:p:1025-1041
Contact details of provider: Postal:
7240 Parkway Drive, Suite 300, Hanover, MD 21076 USA

Phone: +1-443-757-3500
Fax: 443-757-3515
Web page: http://www.informs.org/
Email:


More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Zvi Bodie & Robert C. Merton & William F. Samuelson, 1992. "Labor Supply Flexibility and Portfolio Choice in a Life-Cycle Model," NBER Working Papers 3954, National Bureau of Economic Research, Inc.
  2. Todd Sinai & Nicholas S. Souleles, 2003. "Owner-Occupied Housing as a Hedge Against Rent Risk," NBER Working Papers 9462, National Bureau of Economic Research, Inc.
  3. Pierre-Olivier Gourinchas & Jonathan A. Parker, 1999. "Consumption Over the Life Cycle," NBER Working Papers 7271, National Bureau of Economic Research, Inc.
  4. John Cotter & Richard Roll, 2010. "A Comparative Anatomy of REITs and Residential Real Estate Indexes: Returns, Risks and Distributional Characteristics," Working Papers 201008, Geary Institute, University College Dublin.
  5. Kraft, Holger & Steffensen, Mogens, 2008. "Optimal Consumption and Insurance: A Continuous-time Markov Chain Approach," ASTIN Bulletin: The Journal of the International Actuarial Association, Cambridge University Press, vol. 38(01), pages 231-257, May.
  6. Bullard, James & Feigenbaum, James, 2007. "A leisurely reading of the life-cycle consumption data," Journal of Monetary Economics, Elsevier, vol. 54(8), pages 2305-2320, November.
  7. Thurow, Lester C, 1969. "The Optimum Lifetime Distribution of Consumption Expenditures," American Economic Review, American Economic Association, vol. 59(3), pages 324-30, June.
  8. Thomas Davidoff & Jeffrey R. Brown & Peter A. Diamond, 2005. "Annuities and Individual Welfare," American Economic Review, American Economic Association, vol. 95(5), pages 1573-1590, December.
  9. Joao Cocco & John Campbell, 2004. "Household Risk Management and Optimal Mortgage Choice," Econometric Society 2004 North American Winter Meetings 632, Econometric Society.
  10. Sanford J. Grossman & Guy Laroque, 1987. "Asset Pricing and Optimal Portfolio Choice in the Presence of Illiquid Durable Consumption Goods," NBER Working Papers 2369, National Bureau of Economic Research, Inc.
  11. Marjorie Flavin & Takashi Yamashita, 2002. "Owner-Occupied Housing and the Composition of the Household Portfolio," American Economic Review, American Economic Association, vol. 92(1), pages 345-362, March.
  12. Gary Hansen & Selahattin Imrohoroglu, 2008. "Consumption over the Life Cycle: The Role of Annuities," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(3), pages 566-583, July.
  13. Rui Yao, 2005. "Optimal Consumption and Portfolio Choices with Risky Housing and Borrowing Constraints," Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 197-239.
  14. Martin Browning & Thomas F. Crossley, 2001. "The Life-Cycle Model of Consumption and Saving," Journal of Economic Perspectives, American Economic Association, vol. 15(3), pages 3-22, Summer.
  15. Joao F. Cocco, 2005. "Portfolio Choice in the Presence of Housing," Review of Financial Studies, Society for Financial Studies, vol. 18(2), pages 535-567.
  16. Eugene Fama & F. & Kenneth R. French, . "The Equity Premium."," CRSP working papers 522, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  17. Luis M. Viceira, 2001. "Optimal Portfolio Choice for Long-Horizon Investors with Nontradable Labor Income," Journal of Finance, American Finance Association, vol. 56(2), pages 433-470, 04.
  18. Lars Nielsen & Maria Vassalou, 2006. "The instantaneous capital market line," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 28(3), pages 651-664, 08.
  19. Jun Liu, 2007. "Portfolio Selection in Stochastic Environments," Review of Financial Studies, Society for Financial Studies, vol. 20(1), pages 1-39, January.
  20. 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.
  21. Munk, Claus & Sørensen, Carsten, 2010. "Dynamic asset allocation with stochastic income and interest rates," Journal of Financial Economics, Elsevier, vol. 96(3), pages 433-462, June.
  22. Joao F. Cocco, 2005. "Consumption and Portfolio Choice over the Life Cycle," Review of Financial Studies, Society for Financial Studies, vol. 18(2), pages 491-533.
  23. Otto Van Hemert, 2010. "Household Interest Rate Risk Management," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 38(3), pages 467-505.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:inm:ormnsc:v:57:y:2011:i:6:p:1025-1041. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Mirko Janc)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.