Optimal Portfolio Choice with Predictability in House Prices and Transaction Costs
European Central Bank (ECB)
Jose L. Fillat
Federal Reserve Banks - Federal Reserve Bank of Boston
IESE Business School
February 14, 2009
We study a model of portfolio choice with housing in which house price is predictable. Housing is illiquid in that a transaction cost must be paid when the house is sold. We show that two state variables affect the agent's decisions: (i) the wealth-house
ratio, and (ii) the time-varying mean rate of house price growth. The agent increases (decreases) his housing asset holding only when the wealth-house ratio reaches an optimal upper (lower) boundary. These boundaries are time-varying and will decrease (increase) when house prices are expected to rise (fall). Implications for portfolio rules and housing asset holding are examined. Finally, we use PSID data to test the implications of our model.
Number of Pages in PDF File: 36
Keywords: Portfolio Choice, Predictability, House Prices, Transaction Costs, Real Estate Bubbles
JEL Classification: G1, G11, C61, D11, R2, R20, R21
Date posted: February 14, 2009 ; Last revised: November 20, 2009
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