Optimal Portfolio Choice with Predictability in House Prices and Transaction Costs
36 Pages Posted: 14 Feb 2009 Last revised: 20 Nov 2009
Date Written: 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.
Keywords: Portfolio Choice, Predictability, House Prices, Transaction Costs, Real Estate Bubbles
JEL Classification: G1, G11, C61, D11, R2, R20, R21
Suggested Citation: Suggested Citation