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Optimal portfolio choice with predictability in house prices and transaction costs


  • Corradin, Stefano

    (European Central Bank)

  • Fillat, Jose L.

    (Federal Reserve Bank of Boston)

  • Vergara, Carles

    () (IESE Business School)


Are housing returns predictable? If so, do households take them into account when making their housing consumption and portfolio decisions? We document the existence of housing return predictability in the U.S. at the aggregate, census region, and state level. We study a portfolio choice model in which housing returns are predictable and adjustment costs must be paid when a house is purchased or sold. We show that two state variables affect the agent's decisions: 1) her wealth-to-housing ratio; and 2) the time-varying expected growth rate of house prices. The agent buys (sells) her housing assets only when the wealth-to-housing ratio reaches an optimal upper (lower) bound. These bounds are time-varying and depend on the expected growth rate of house prices. Finally, we use household level data from the PSID and SIPP surveys to test and support the model's main implications.

Suggested Citation

  • Corradin, Stefano & Fillat, Jose L. & Vergara, Carles, 2012. "Optimal portfolio choice with predictability in house prices and transaction costs," IESE Research Papers D/948, IESE Business School.
  • Handle: RePEc:ebg:iesewp:d-0948

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    References listed on IDEAS

    1. John Y. Campbell & Luis M. Viceira, 1999. "Consumption and Portfolio Decisions when Expected Returns are Time Varying," The Quarterly Journal of Economics, Oxford University Press, vol. 114(2), pages 433-495.
    2. Andrew Ang & Geert Bekaert, 2002. "International Asset Allocation With Regime Shifts," Review of Financial Studies, Society for Financial Studies, vol. 15(4), pages 1137-1187.
    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.
    6. 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.
    7. University of Chicago & Jose L. Fillat, 2008. "Housing as a Measure for the Long Run Risk in Asset Pricing," 2008 Meeting Papers 483, Society for Economic Dynamics.
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    Cited by:

    1. Carlos Hatchondo, Juan & Martinez, Leonardo & Sánchez, Juan M., 2015. "Mortgage defaults," Journal of Monetary Economics, Elsevier, vol. 76(C), pages 173-190.
      • Hatchondo, Juan Carlos & Martinez, Leonardo & Sánchez, Juan M., 2011. "Mortgage defaults," Working Papers 2011-019, Federal Reserve Bank of St. Louis, revised 31 Jul 2015.
      • Leonardo Martinez & Juan Carlos Hatchondo & Juan M. Sanchez, 2012. "Mortgage Defaults," IMF Working Papers 12/26, International Monetary Fund.
      • Juan Carlos Hatchondo & Leonardo Martinez & Juan M. Sanchez, 2015. "Mortgage Defaults," Caepr Working Papers 2015-011 Classification-D, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
      • Juan Carlos Hatchondo & Leonardo Martinez & Juan M. Sanchez, 2011. "Mortgage defaults," Working Paper 11-05, Federal Reserve Bank of Richmond.
    2. Corradin, Stefano & Gropp, Reint & Huizinga, Harry & Laeven, Luc, 2010. "Who Invests in Home Equity to Exempt Wealth from Bankruptcy?," CEPR Discussion Papers 8097, C.E.P.R. Discussion Papers.
    3. Maj-Britt Nordfang & Mogens Steffensen, 2017. "Portfolio Optimization and Mortgage Choice," Journal of Risk and Financial Management, MDPI, Open Access Journal, vol. 10(1), pages 1-21, January.
    4. Caterina Mendicino, 2014. "House prices and expectations," Research Bulletin, European Central Bank, vol. 21, pages 12-15.
    5. Stefano Corradin, 2013. "House Prices, Household Leverage, and Entrepreneurship," 2013 Meeting Papers 631, Society for Economic Dynamics.
    6. Imran Hussain Shah & Simón Sosvilla-Rivero, 2017. "Seeking price and macroeconomic stabilisation in the euro area: The role of house prices and stock prices," IREA Working Papers 201710, University of Barcelona, Research Institute of Applied Economics, revised May 2017.
    7. Fontana, Alessandro & Corradin, Stefano, 2013. "House price cycles in Europe," Working Paper Series 1613, European Central Bank.
    8. European Central Bank & Stefano Corradin, 2009. "Household Leverage," 2009 Meeting Papers 906, Society for Economic Dynamics.
    9. Popov, Alexander & Corradin, Stefano, 2013. "House prices, home equity and entrepreneurships," Working Paper Series 1544, European Central Bank.
    10. Paloma Lopez-Garcia & Filippo di Mauro, 2014. "Assessing competitiveness: initial results from the new compnet micro-based database," Research Bulletin, European Central Bank, vol. 21, pages 2-7.
    11. Torben Klarl, 2016. "The nexus between housing and GDP re-visited: A wavelet coherence view on housing and GDP for the U.S," Economics Bulletin, AccessEcon, vol. 36(2), pages 704-720.
    12. Davis, Morris A. & Van Nieuwerburgh, Stijn, 2015. "Housing, Finance, and the Macroeconomy," Handbook of Regional and Urban Economics, Elsevier.
    13. Corradin, Stefano & Gropp, Reint & Huizinga, Harry & Laeven, Luc, 2016. "The effect of personal bankruptcy exemptions on investment in home equity," Journal of Financial Intermediation, Elsevier, vol. 25(C), pages 77-98.
    14. 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).
    15. Kraft, Holger & Munk, Claus & Wagner, Sebastian, 2015. "Housing habits and their implications for life-cycle consumption and investment," SAFE Working Paper Series 85, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
    16. Sebastian Schmidt, 2014. "Dealing with a liquidity trap when government debt matters," Research Bulletin, European Central Bank, vol. 21, pages 8-11.
    17. Kraft, Holger & Munk, Claus & Weiss, Farina, 2016. "Predictors and portfolios over the life cycle," SAFE Working Paper Series 139, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.

    More about this item


    Portfolio choice; predictability; house prices; household finance;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis

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