Rising Earnings Instability, Portfolio Choice, and Housing Prices

49 Pages Posted: 1 Oct 2009

See all articles by Makoto Nakajima

Makoto Nakajima

Federal Reserve Bank of Philadelphia

Date Written: July 3, 2005

Abstract

This paper studies the effects of the U.S. rising earnings inequality between the late 1960s and the mid 1990s on the portfolio allocation and prices of assets. In order to investigate the link, a life-cycle general equilibrium model is constructed where distinct characteristics of the housing asset is explicitly modeled and asset prices are determined in equilibrium. It is shown that the model can produce a 9% rise in the housing price, which is about 40% of the changes in the U.S. data (24%). An increased demand for precautionary savings and the general equilibrium effect play a crucial role here. A higher earnings volatility induces a higher demand for financial assets. As the return of financial assets declines due to the general equilibrium effect, the demand for housing assets increases as well. The paper also examines the effects of the rising earnings inequality on the aggregate amount of debt. Interestingly, contrary to the U.S. data, the model predicts a decline in the total amount of secured debt. A higher earnings volatility induces a higher amount of debt in complete markets models, but an increased demand for savings for precautionary motive dominates the positive effect to the amount of debt. The model also shows that incorporating housing assets into the model does not make a significant difference in the effect of the rising earnings inequality on the consumption inequality.

Keywords: House price, General equilibrium, Incomplete markets, Income inequality, Debt

JEL Classification: E21, E24, G11, G21, R21

Suggested Citation

Nakajima, Makoto, Rising Earnings Instability, Portfolio Choice, and Housing Prices (July 3, 2005). Available at SSRN: https://ssrn.com/abstract=1480816 or http://dx.doi.org/10.2139/ssrn.1480816

Makoto Nakajima (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

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