Portfolio choices for homeowners

In this paper, I show that introducing frictions associated with housing into standard life-cycle models can partially resolve the portfolio choice puzzle. I calibrate a model in which a representative household endogenously transits from renting to mortgage-financed homeownership. The household can later adjust housing status either voluntarily or because of a forced move, by paying transaction costs. It is shown that homeownership crowds out stock market participation: risky owner-occupied housing substitutes for stocks while bonds provide liquidity. Young and middle-aged households, regardless of whether they are currently homeowners, hold much less stock than predicted by traditional models without housing. (c) 2005 Elsevier Inc. All rights reserved.