Homeownership as a Constraint on Asset Allocation

Posted: 11 Oct 2006

See all articles by Stephen Day Cauley

Stephen Day Cauley

University of California, Los Angeles (UCLA) - Finance Area

Eduardo S. Schwartz

University of California, Los Angeles (UCLA) - Finance Area; Simon Fraser University (SFU); National Bureau of Economic Research (NBER)

Andrey D. Pavlov

Simon Fraser University (SFU) - Finance Area

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Abstract

Personal preferences and financial incentives make homeownership desirable for most families. Once a family purchases a home they find it impractical (costly) to frequently change their ownership of residential real estate. Thus, by deciding how much home to buy, a family constrains their ability to adjust their asset allocation between residential real estate and other assets. To analyze the impact of this constraint on consumption, welfare, and post-retirement wealth, we first investigate an individual's optimal asset allocation decisions when they are subject to a homeownership constraint. Next, we perform a thought experiment where we assume the existence of a market where a homeowner can sell, without cost, a fractional interest in their home. Now the housing choice decision does not constrain the individual's asset allocations. By comparing these two cases, we estimate the differences in post-retirement wealth and the welfare gains potentially realizable if asset allocations wee not subject to a homeownership constraint. For realistic parameter values, we find that the homeowner would require a substantial increase in total net worth to achieve the same level of utility as would be achievable if the choice of a home could be separated from the asset allocation decision. The robustness of the analysis is evaluated with respect to the model's parameters and initial state variables. We find that changes in the values of the constraint (i.e., the value of the home) and the expected real rate of home value appreciation are the only state variables or parameter that is associated with a large change in asset allocation and/or the burden imposed by the housing constraint. This finding suggests the importance of a detailed examination of the impact of inter-regional differences in home prices and expected rates of appreciation on asset allocation and post-retirement wealth.

Suggested Citation

Cauley, Stephen Day and Schwartz, Eduardo S. and Schwartz, Eduardo S. and Pavlov, Andrey D., Homeownership as a Constraint on Asset Allocation. Journal of Real Estate Finance and Economics, Vol. 34, No. 3, 2007, Available at SSRN: https://ssrn.com/abstract=936413

Stephen Day Cauley (Contact Author)

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-1131 (Phone)
310-825-9528 (Fax)

Eduardo S. Schwartz

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-1953 (Phone)
310-206-5455 (Fax)

Simon Fraser University (SFU) ( email )

8888 University Drive
Burnaby, British Columbia V5A 1S6
Canada

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Andrey D. Pavlov

Simon Fraser University (SFU) - Finance Area ( email )

Vancouver, British Columbia V5A 1S6
Canada
604 291 5835 (Phone)
604 291 4920 (Fax)

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