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Owner-Occupied Housing and the Composition of the Household Portfolio over the Life Cycle

  • Flavin, Marjorie
  • Yamashita, Takashi
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    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.

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    File URL: http://www.escholarship.org/uc/item/89x293v9.pdf;origin=repeccitec
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    Paper provided by Department of Economics, UC San Diego in its series University of California at San Diego, Economics Working Paper Series with number qt89x293v9.

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    Date of creation: 01 Jan 1998
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    Handle: RePEc:cdl:ucsdec:qt89x293v9
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    1. William N. Goetzmann & Roger G. Ibbotson, 1990. "The Performance Of Real Estate As An Asset Class," Journal of Applied Corporate Finance, Morgan Stanley, vol. 3(1), pages 65-76.
    2. 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.
    3. Sharpe, William F., 1990. "Capital Asset Prices With and Without Negative Holding," Nobel Prize in Economics documents 1990-3, Nobel Prize Committee.
    4. Engelhardt, Gary V., 1996. "House prices and home owner saving behavior," Regional Science and Urban Economics, Elsevier, vol. 26(3-4), pages 313-336, June.
    5. Hilary Williamson Hoynes & Daniel McFadden, 1994. "The Impact of Demographics on Housing and Non-Housing Wealth in the United States," NBER Working Papers 4666, National Bureau of Economic Research, Inc.
    6. Robert S. Pindyck, 1986. "Risk Aversion and Determinants of Stock Market Behavior," NBER Working Papers 1921, National Bureau of Economic Research, Inc.
    7. Levy, H & Markowtiz, H M, 1979. "Approximating Expected Utility by a Function of Mean and Variance," American Economic Review, American Economic Association, vol. 69(3), pages 308-17, June.
    8. Goetzmann, W.N., 1990. "The Single Family Home In The Investment Portfolio," Papers fb-_90-15, Columbia - Graduate School of Business.
    9. James M. Poterba & Andrew Samwick, 2001. "Household Portfolio Allocation over the Life Cycle," NBER Chapters, in: Aging Issues in the United States and Japan, pages 65-104 National Bureau of Economic Research, Inc.
    10. Grossman, Sanford J & Shiller, Robert J, 1981. "The Determinants of the Variability of Stock Market Prices," American Economic Review, American Economic Association, vol. 71(2), pages 222-27, May.
    11. Blake, David, 1996. "Efficiency, Risk Aversion and Portfolio Insurance: An Analysis of Financial Asset Portfolios Held by Investors in the United Kingdom," Economic Journal, Royal Economic Society, vol. 106(438), pages 1175-92, September.
    12. Ross, Stephen A & Zisler, Randall C, 1991. "Risk and Return in Real Estate," The Journal of Real Estate Finance and Economics, Springer, vol. 4(2), pages 175-90, June.
    13. Brueckner, Jan K, 1997. "Consumption and Investment Motives and the Portfolio Choices of Homeowners," The Journal of Real Estate Finance and Economics, Springer, vol. 15(2), pages 159-80, October.
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