Optimal Asset and Housing Allocation with a Path-Dependent Housing Adjustment Cost

Abstract

We analyze the asset allocations of homeowners and renters in a life-cycle model with housing and mortgage decisions. Our model has a housing adjustment cost, which depends on the remaining mortgage balance, implying that the tenure choice of a housing investment matters in explaining the wealth compositions of households across age groups and homeownership status. We also include alternative forms of bequest to the young home buyers, a realistic feature of the housing investment. We find that our simulated model can match quantitatively the hump shape of homeownership and increasing stock holding shares for owners and renters over their life cycles.

Keywords: Asset allocation, Housing investment, Mortgage contracts, Bequest, Path-dependent Housing Adjustment Cost

JEL Classification: D91, E21, G11, G21, R21