Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/39046 
Year of Publication: 
2009
Series/Report no.: 
Working Paper Series: Finance & Accounting No. 197
Publisher: 
Johann Wolfgang Goethe-Universität Frankfurt am Main, Fachbereich Wirtschaftswissenschaften, Frankfurt a. M.
Abstract: 
We provide explicit solutions to life-cycle utility maximization problems simultaneously involving dynamic decisions on investments in stocks and bonds, consumption of perishable goods, and the rental and the ownership of residential real estate. House prices, stock prices, interest rates, and the labor income of the decision-maker follow correlated stochastic processes. The preferences of the individual are of the Epstein-Zin recursive structure and depend on consumption of both perishable goods and housing services. The explicit consumption and investment strategies are simple and intuitive and are thoroughly discussed and illustrated in the paper. For a calibrated version of the model we find, among other things, that the fairly high correlation between labor income and house prices imply much larger life-cycle variations in the desired exposure to house price risks than in the exposure to the stock and bond markets. We demonstrate that the derived closed-form strategies are still very useful if the housing positions are only reset infrequently and if the investor is restricted from borrowing against future income. Our results suggest that markets for REITs or other financial contracts facilitating the hedging of house price risks will lead to non-negligible but moderate improvements of welfare.
Subjects: 
Housing
labor income
portfolio choice
life-cycle decisions
recursive utility
REITs
JEL: 
G11
D14
D91
C6
Document Type: 
Working Paper

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