Residential housing, household portfolio, and intertemporal elasticity of substitution

Abstract

In this dissertation, I investigate whether the return on a household portfolio and the inclusion of residential housing in a portfolio are important to the household’s intertemporal consumption choice. In particular, my first essay investigates whether the rate of interest such as the Treasury bill rate or the rate of return such as the return on a household portfolio is more relevant to the household’s intertemporal decision making. In the current era, households hold portfolios of assets, which earn composite returns accounting for capital gains, taxes, and inflation. In addition to stocks and bonds, I incorporate residential housing into a household portfolio. The computed total composite return, a weighted average return on the aggregate household portfolio, is then use v estimating the intertemporal elasticity of substitution (IES), a parameter measuring the response of household’s consumption growth to a change in a rate of return. The estimates obtained using the real after-tax composite return with aggregate consumption are about 0.15-0.3 and are more robust to linear and nonlinear estimations, different consumption measures, and various time periods than those obtained by using individual asset returns such as the Treasury bill rate. My second essay is devoted to measuring and analyzing the return on aggregate residential housing. This essay further investigates a major component of the composite return that is not as straightforwardly computed as financial asset returns. In constructing real after-tax total return on housing, I account for rental income, capital gain, and subsidies due to the tax provisions for homeowners. This is a more comprehensive measure of return than that found in the literature. I find that residential housing provides high average return and low volatility, has low correlation with other assets such as stocks and bonds, exhibits high positive correlation with inflation, and should be a major part of the household portfolio. Lastly, the third essay of the dissertation explores the impact of the inclusion of housing in a household portfolio on the IES using household-level data from the Consumer Expenditure Survey. Moreover, utilizing a household level data set, I estimate IES parameters for different groups of assetholders. My results indicate that housing return positively affects consumption growth, and that housing is an important asset in the household portfolio.