Owner-Occupied Housing and the Composition of the Household Portfolio

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Abstract
For most homeowners, the house is the single most important consumption good appearing as an argument of the utility function, and, at the same time, the dominant asset in the portfolio. This paper uses a mean-variance efé ciency framework to examine the household' s optimal portfolio problem when owner-occupied hous- ing is included in the list of available assets. Housing differs from stocks and bonds in a crucial way: since the household' s ownership of residential real estate determines the level of its consumption of housing services, the house- hold' s demand for real estate is " overdeter- mined" in the sense that the level of real estate ownership which is optimal from the point of view of the consumption of housing services may differ from the optimal level of housing assets from a portfolio point of view. With rental markets for housing, a household can, in principle, divorce the size of its holdings of real estate assets from the level of housing services it consumes. However, rental housing is by no means a perfect substitute for owner-occupied housing. We assume, instead, that the preferen- tial tax treatment of owner-occupied housing and the transactions costs and agency costs in- volved in the rental market for housing create frictions large enough to effectively constrain the household to include in its asset portfolio the level of housing consistent with its consumption of housing services. 1

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