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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

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.

Suggested Citation

  • Flavin, Marjorie & Yamashita, Takashi, 1998. "Owner-Occupied Housing and the Composition of the Household Portfolio over the Life Cycle," University of California at San Diego, Economics Working Paper Series qt89x293v9, Department of Economics, UC San Diego.
  • Handle: RePEc:cdl:ucsdec:qt89x293v9
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    References listed on IDEAS

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    Cited by:

    1. 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.
    2. Fuad Hasanov & Douglas Dacy, 2005. "Measuring and Analyzing Returns on Aggregate Residential Housing," Finance 0510005, EconWPA.
    3. Englund, Peter & Hwang, Min & Quigley, John M, 2002. "Hedging Housing Risk," The Journal of Real Estate Finance and Economics, Springer, vol. 24(1-2), pages 167-200, Jan.-Marc.
    4. Ji, Tingting, 2004. "Essays on consumer portfolio choice and credit risk," MPRA Paper 3161, University Library of Munich, Germany.
    5. Hochguertel, Stefan & van Soest, Arthur, 2001. "The Relation between Financial and Housing Wealth: Evidence from Dutch Households," Journal of Urban Economics, Elsevier, vol. 49(2), pages 374-403, March.
    6. Carol C. 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.).
    7. Boehm, Thomas P. & Schlottmann, Alan M., 2004. "The dynamics of race, income, and homeownership," Journal of Urban Economics, Elsevier, vol. 55(1), pages 113-130, January.
    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. Andersson, Björn, 2001. "Portfolio Allocation over the Life Cycle: Evidence from Swedish Household Data," Working Paper Series 2001:4, Uppsala University, Department of Economics.
    10. Joseph Nichols, 2004. "A Life-cycle Model with Housing, Portfolio Allocation, and Mortgage Financing," Econometric Society 2004 North American Winter Meetings 205, Econometric Society.
    11. 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.

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