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Homeownership as a Constraint on Asset Allocation

  • Author(s): Cauley, Stephen D
  • Pavlov, Andrey D.
  • Schwartz, Eduardo S
  • et al.
Abstract

Personal preferences and financial incentives make homeownership desirable for most families. Once a family purchases a home 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 a substantial 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.

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