Portfolio Choice with Complementary Housing
28 Pages Posted: 25 Mar 2005
Date Written: November 2004
Previous housing portfolio choice studies assume an intratemporal elasticity of substitution between housing services and nondurable consumption that is greater than or equal to one. I show that a much lower elasticity of substitution is more consistent with the data on two fronts. First, the optimal demand for stocks is significantly lower when housing and nondurable consumption are complementary goods. This helps explain the puzzlingly low proportion of stocks relative to bonds in oberserved household portfolios. Second, the simulated cross-sectional correlation between the ratios of housing-to-net worth and nondurable consumption-to-net worth is much higher when preferences over housing and nondurable consumption are complementary. This high level of correlation is more consistent with data in the Consumer Expenditures Survey.
Keywords: housing, portfolio choice
JEL Classification: G11
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