Optimal Portfolio Choice with Predictability in House Prices and Transaction Costs
80 Pages Posted: 24 Sep 2012
There are 4 versions of this paper
Optimal Portfolio Choice with Predictability in House Prices and Transaction Costs
Optimal Portfolio Choice with Predictability in House Prices and Transaction Costs
Optimal Portfolio Choice with Predictability in House Prices and Transaction Costs
Optimal Portfolio Choice with Predictability in House Prices and Transaction Costs
Date Written: September 18, 2012
Abstract
We generalize the classic Grossman and Laroque (1990) (GL) model of optimal portfolio choice with housing and transaction costs by introducing predictability in house prices. As in the GL model, agents only move to more expensive (cheaper) houses when their wealth-to-housing ratios reach an optimal lower (upper) boundary. However, in our model, these boundaries are time-varying and depend on the dynamics of the expected growth rate of house prices. We find that households moving to a more expensive house in periods of high expected growth in house prices have significantly lower ex-ante wealth-to-housing ratios than those moving in periods of low expected growth. We also find that the share of wealth invested in risky assets is lower during periods of high expected growth in house prices and that it is higher right before moving during periods of low growth. The main implications of the model are robust to tests using household level data from the PSID and SIPP surveys.
Keywords: durable goods, transaction costs, housing returns predictability, optimal housing consumption and investment
JEL Classification: G11, D11, D91, C61
Suggested Citation: Suggested Citation
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