The Effect of Housing on Portfolio Choice
Economic theory predicts that home ownership should generally have a negative effect on risk-taking in financial portfolios, a result that affects the optimal design of a wide variety of financial and insurance policies. However, empirical work has not found a strong relationship between housing and portfolios. We identify two reasons for the divergence between the theory and data. First, it is critical to distinguish between home equity wealth and mortgage debt, as they have opposite-signed effects on portfolio choice. Second, it is important to isolate variation in home equity wealth and mortgage debt that is orthogonal to unobserved determinants of portfolios. We estimate a model that permits home equity wealth and mortgage debt to have different effects on portfolio shares. We isolate plausibly exogenous variation in home equity and mortgages by using differences across housing markets in average house prices and housing supply elasticities as instruments. Using data for 60,000 households, we find that increases in mortgage debt reduce stockholding significantly, while increases in home equity wealth raise stockholding. On net, an individual with 10% more mortgage debt and home equity has a 3% ower portfolio share of stocks. We conclude that housing has substantial impacts on portfolio choice, as theory predicts.
This paper was revised on February 13, 2012