Homeownership as a Constraint on Asset Allocation

42 Pages Posted: 22 Mar 2005  

Stephen Day Cauley

University of California, Los Angeles (UCLA) - Finance Area

Andrey D. Pavlov

Simon Fraser University (SFU) - Finance Area

Eduardo S. Schwartz

University of California, Los Angeles (UCLA) - Finance Area; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: March 2005

Abstract

Personal preferences and financial incentives make homeownership desirable for most families. Once a home is purchased they find it impractical (costly) to frequently change their ownership of residential real estate. Thus, by deciding how much home to buy, a family constrains their ability to adjust their asset allocation between residential real estate and other assets. To analyze the impact of this constraint on consumption, welfare, and post-retirement wealth, we first investigate a representative individual's optimal asset allocation decisions when they are subject to a "homeownership constraint." Next, we perform a "thought experiment" where we assume the existence of a market where a homeowner can sell, without cost, a fractional interest in their home. Now the housing choice decision does not constrain the individual's asset allocations. By comparing these two cases, we estimate the differences in post-retirement wealth and the welfare gains potentially realizable if asset allocations were not subject to a homeownership constraint. For realistic parameter values, we find that a representative homeowner would require between a 2 and 25 percent increase in total net worth to achieve the same level of utility as would be achievable if the choice of a home could be separated from the asset allocation decision.

Keywords: Asset allocation, housing

JEL Classification: G12

Suggested Citation

Cauley , Stephen Day and Pavlov, Andrey D. and Schwartz, Eduardo S., Homeownership as a Constraint on Asset Allocation (March 2005). Available at SSRN: https://ssrn.com/abstract=687162 or http://dx.doi.org/10.2139/ssrn.687162

Stephen Day Cauley

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-1131 (Phone)
310-825-9528 (Fax)

Andrey D. Pavlov

Simon Fraser University (SFU) - Finance Area ( email )

Burnaby, British Columbia V5A 1S6
Canada
604 291 5835 (Phone)
604 291 4920 (Fax)

Eduardo S. Schwartz (Contact Author)

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-1953 (Phone)
310-206-5455 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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