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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.

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Paper provided by IESE Business School in its series IESE Research Papers with number D/948.

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Length: 96 pages
Date of creation: 03 Feb 2012
Date of revision:
Handle: RePEc:ebg:iesewp:d-0948
Contact details of provider: Postal: IESE Business School, Av Pearson 21, 08034 Barcelona, SPAIN
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  1. John Y. Campbell & Luis M. Viceira, 1998. "Consumption and Portfolio Decisions When Expected Returns Are Time Varying," Harvard Institute of Economic Research Working Papers 1835, Harvard - Institute of Economic Research.
  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. 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.
  4. 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.
  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. 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.
  7. 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.).
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