Optimal Portfolio Choice with Predictability in House Prices and Transaction Costs
95 Pages Posted: 1 Dec 2010 Last revised: 15 Feb 2012
Date Written: December 2011
Are housing prices predictable? If so, do households take into account it when making their portfolio choices? We document the existence of housing returns predictability in the US at the aggregate and regional level. We study a model, in which housing prices are predictable and adjustment costs must be paid when there is a housing transaction. We show that two state variables affect the agent's decisions: (i) his wealth-house ratio; and (ii) the time-varying expected growth rate of housing prices. The agent buys (sells) his housing assets only when the wealth-to-housing ratio reaches an optimal upper (lower) bound. These bounds are time-varying and depend on the expected growth rate of housing prices. Finally, we use household level data from the PSID and SIPP surveys to test and support the main implications of the model.
JEL Classification: E3
Suggested Citation: Suggested Citation