- Optimal housing, consumption, and investment decisions over the life-cycle (2009)
- We provide explicit solutions to life-cycle utility maximization problems simultaneously involving dynamic decisions on investments in stocks and bonds, consumption of perishable goods, and the rental and the ownership of residential real estate. House prices, stock prices, interest rates, and the labor income of the decision-maker follow correlated stochastic processes. The preferences of the individual are of the Epstein-Zin recursive structure and depend on consumption of both perishable goods and housing services. The explicit consumption and investment strategies are simple and intuitive and are thoroughly discussed and illustrated in the paper. For a calibrated version of the model we find, among other things, that the fairly high correlation between labor income and house prices imply much larger life-cycle variations in the desired exposure to house price risks than in the exposure to the stock and bond markets. We demonstrate that the derived closed-form strategies are still very useful if the housing positions are only reset infrequently and if the investor is restricted from borrowing against future income. Our results suggest that markets for REITs or other financial contracts facilitating the hedging of house price risks will lead to non-negligible but moderate improvements of welfare. JEL-Classification: G11, D14, D91, C6
- Investment, income, incompleteness (2009)
- The utility-maximizing consumption and investment strategy of an individual investor receiving an unspanned labor income stream seems impossible to find in closed form and very dificult to find using numerical solution techniques. We suggest an easy procedure for finding a specific, simple, and admissible consumption and investment strategy, which is near-optimal in the sense that the wealthequivalent loss compared to the unknown optimal strategy is very small. We first explain and implement the strategy in a simple setting with constant interest rates, a single risky asset, and an exogenously given income stream, but we also show that the success of the strategy is robust to changes in parameter values, to the introduction of stochastic interest rates, and to endogenous labor supply decisions. JEL-Classification: G11
- Consumption habits and humps (2013)
- We show that the optimal consumption of an individual over the life cycle can have the hump shape (inverted U-shape) observed empirically if the preferences of the individual exhibit internal habit formation. In the absence of habit formation, an impatient individual would prefer a decreasing consumption path over life. However, because of habit formation, a high initial consumption would lead to high required consumption in the future. To cover the future required consumption, wealth is set aside, but the necessary amount decreases with age which allows consumption to increase in the early part of life. At some age, the impatience outweighs the habit concerns so that consumption starts to decrease. We derive the optimal consumption strategy in closed form, deduce sufficient conditions for the presence of a consumption hump, and characterize the age at which the hump occurs. Numerical examples illustrate our findings. We show that our model calibrates well to U.S. consumption data from the Consumer Expenditure Survey.