Modelling Households' Savings and Dwellings Investment - A Portfolio Choice Approach
A house is generally considered as a 'roof over one's head', however, housing can be regarded as an investment or asset. Our paper focuses on this function of dwellings and develops a stochastic portfolio choice model for the housing market, which is easy to incorporate into medium and large-scale macro models. Theoretical results suggest that house prices move in line with households' income, although house prices have a higher variance than income does. On the other hand the positive correlation between the return on housing investment and consumption not only implies positive relationship between the portfolio share of housing investment and excess return but also renders the housing wealth inappropriate in consumption smoothing. We use UK data to test these theoretical implications of the model. In this case, empirical results strengthen the model framework.
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