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Abstract: The theoretical mean-variance efficient portfolio model was modified to incorporate human wealth and net primary residence. Eight traded assets were selected to represent the set of risky assets available to the household investors: combined stock index, large stocks, small stocks, the average return series for individual stocks in the CRSP Decile 10 (smallest) stock portfolio to proxy business ownership, corporate bonds, long-term government bonds, intermediate government bonds, and Ibbotson AssociateŁŒs real estate return series. Treasury bill represents the risk-free rate in this study. Simulation programs were developed to identify the efficient portfolios by finding the portfolio weights in risky assets that result in the minimum-variance frontier for the total portfolio. The results of the simulation programs give the efficient asset allocations to different household investors with different human wealth ratios, net primary residence ratios, and planned investment horizons, once the diversification of investment portfolios are related to the perceived stability of future employment income. The simulation results show that when rational household investors have a high human wealth ratio (e.g., those with ages between 30 to 40 years old), and a long investment time horizon (e.g., 15 year before their retirement), their efficient frontier is a combination of intermediate government bond, real estate, large stocks, small stocks and business ownership. People with high risk aversion should invest in intermediate government bonds and real estate for a 15-year horizon. People with low risk aversion should invest in real estate, small stock funds, and business ownership for a 15-year horizon. People who have risk aversion between these two points should choose a combination in the order of intermediate government bonds, real estate, large stocks, small stocks, and business ownership. The efficient portfolios from the simulation results are compared to the current portfolios of U.S. households estimated from the 1998 Survey of Consumer Finances. In the formal efficiency test of householdsŁŒ current portfolios, about one-third of total households hold inefficient mean-variance portfolios, compared with the same characteristics as those used to produce the simulation results in this study.
Theoretical and empirical analysis of the structure of household portfolios.
We address the issue of the efficiency of household portfolios in the presence of housing risk. We treat housing stock as an asset and rents as a stochastic liability stream: over the life-cycle, households can be short or long in their net housing position. Efficient financial portfolios are the sum of a standard Markowitz portfolio and a housing risk hedge term that multiplies net housing wealth. Our empirical results show that net housing plays a key role in determining which household portfolios are inefficient. The largest proportion of inefficient portfolios obtains among those with positive net housing, who should invest more in stocks.
"This paper proposes a method for predicting the probability density of a variable of interest in the presence of model ambiguity. In the first step, each candidate parametric model is estimated minimizing the Kullback-Leibler 'distance' (KLD) from a reference nonparametric density estimate. Given that the KLD represents a measure of uncertainty about the true structure, in the second step, its information content is used to rank and combine the estimated models.
In this paper we address the issue of the efficiency of household portfolios in the presence of housing risk. We present a theoretical model in which housing needs are age-dependent but exogenously determined, and consumers choose whether to rent or own the corresponding housing stock. Consumers also decide their consumption of a non-durable good and their financial investment strategies. They can invest in a risk-less asset (that includes human capital) and n risky financial assets. If the rental value of housing has a positive correlation with house prices, owning is a hedge against rent risk. When this correlation is unitary, we show that efficient financial portfolios should be the sum of a standard Markowitz portfolio and of a hedge term. This hedge term is a function of the correlations between housing and financial assets returns and multiplies the difference between the value of the housing stock owned and the present value of current and future housing needs.In our application we use Italian household portfolio data and time series data on financial assets and housing stock returns. Our empirical results support the view that the presence of housing risk plays a key role in determining whether household portfolios are efficient. They also highlight the need to distinguish between households who are long on housing (homeowners whose housing needs are declining) or short on housing (tenants and homeowners whose housing needs are still increasing).
In this paper, we study how the portfolios of elderly U.S. households evolve after retirement, using data from the Health and Retirement Study (HRS). In particular, we investigate the influence of aging and health shocks on a household's ownership of various assets and on the dollar value and share of total assets held in each asset class. We find that households decrease their ownership of most asset classes as they age, with the strongest evidence for principal residences and vehicles, while increasing the share of assets held in bank accounts and CDs. Consistent with prior studies, we find that the death of a spouse is a strong predictor of selling the principal residence. However, we find that widowhood also leads households to sell vehicles, businesses, and real estate and to put money into bank accounts and CDs, and further that other health shocks have very similar impacts. Finally, we explore why health shocks affect asset holdings and find that the effect of a shock is greatly magnified when households have physical or mental impairments. This suggests that factors other than standard risk and return considerations may weigh heavily in many older households' portfolio decisions.