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Optimal portfolio choice with predictability in house prices and transaction costs

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Abstract

We study a model of portfolio choice, in which housing prices are predictable and adjustment costs must be paid when there is a housing transaction. We show that two state variables affect the agent's decisions: (i) his wealth-house ratio; and (ii) the time-varying expected growth rate of housing prices. The agent buys (sells) his housing assets only when the wealth-house ratio reaches an optimal upper (lower) boundary. These boundaries are time-varying and depend on the expected growth rate of housing prices. Finally, we use household level data from the PSID and SIPP surveys to test and support the main implications of the model, as well as portfolio rules and holdings of housing asset.

Suggested Citation

  • Stefano Corradin & José Fillat & Carles Vergara-Alert, 2010. "Optimal portfolio choice with predictability in house prices and transaction costs," Supervisory Research and Analysis Working Papers QAU10-2, Federal Reserve Bank of Boston.
    • Handle: RePEc:fip:fedbqu:qau10-2
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    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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