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RFS Advance Access published online on March 26, 2004
Review of Financial Studies, doi:10.1093/rfs/hhh007
Review of Financial Studies © The Society for Financial Studies 2004; all rights reserved
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The Review of Financial Studies © The Society for Financial Studies 2004; all rights reserved.

Original Articles

Optimal Consumption and Portfolio Choices with Risky Housing and Borrowing Constraints

Rui Yao 1 and Harold H. Zhang 2*
1 Department of Economics and Finance, Baruch College, Zicklin School of Business, One Bernard Baruch Way, Box B10-225, New York, New York 10010
2 Kenan-Flagler Business School, The University of North Carolina at Chapel Hill, Chapel Hill, NC 27599

* To whom correspondence should be addressed. E-mail: zhangha{at}kenan-flagler.unc.edu.


  Abstract

We examine the optimal dynamic portfolio decisions for investors who acquire housing services from either renting or owning a house. Our results show that when indifferent between owning and renting, investors owning a house hold a lower equity proportion in their net worth (bonds, stocks and home equity), reflecting the substitution effect, yet hold a higher equity proportion in their liquid portfolios (bonds and stocks), reflecting the diversification effect. Furthermore, following the suboptimal policy of always renting leads investors to overweigh in stocks, while following the suboptimal policy of always owning a house causes investors to underweigh in stocks.


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