Optimal Consumption and Portfolio Choices with Housing Dynamics

Abstract

This study develops a dynamic model to analyze the optimal consumption and portfolio choices of households acquiring housing services through renting or owning. The model incorporates time-varying financial constraints, represented by the liquid wealth-to-house value ratio, to provide a unified framework for decision-making. We examine the optimal timing and size of house purchases, highlighting the role of intergenerational transfers in facilitating homeownership. By employing a recursive utility function that disentangles risk aversion from the elasticity of intertemporal substitution, the model extends beyond the limitations of standard CRRA utility. Empirical validation using data from the China Household Finance Survey reveals strong consistency between theoretical predictions and observed household behaviors, offering new insights into housing and portfolio decisions under financial constraints.