Optimal Portfolio Choice with Predictability in House Prices and Transaction Costs

We study a model of portfolio choice with housing in which house price is predictable. Housing is illiquid in that a transaction cost must be paid when the house is sold. We show that two state variables aff ect the agent's decisions: (i) the wealth-houseratio, and (ii) the time-varying mean rate of house price growth. The agent increases (decreases) his housing asset holding only when the wealth-house ratio reaches an optimal upper (lower) boundary. These boundaries are time-varying and will decrease (increase) when house prices are expected to rise (fall). Implications for portfolio rules and housing asset holding are examined. Finally, we use PSID data to test the implications of our model