Academic journal article Financial Services Review

Home Ownership Decision in Personal Finance: Some Empirical Evidence

Academic journal article Financial Services Review

Home Ownership Decision in Personal Finance: Some Empirical Evidence

Article excerpt

(ProQuest: ... denotes formulae omitted.)

1. Introduction

The home ownership decision is a major decision for most households. All textbooks in personal finance cover the topic in details (e.g., see Madura, 2014). Almost all textbooks examine the home ownership decision as a "buy versus rent" decision. What is lacking in personal finance textbooks is the empirical evidence on whether a typical U.S. household should in fact own a house. This absence of empirical evidence is somewhat unusual given the emphasis on empirical evidence in modern finance. Theory is not enough unless it is supported by empirical evidence. In the literature, there is not much empirical evidence that buying a house is in fact a wise decision. This lack of evidence is a cause for concern since a house is a major asset for most households and the decision is relatively expensive and inconvenient to be reversed. The question of whether a household should purchase a house takes on more urgency since the collapse of the housing market in 2008.

Our article examines empirically whether it pays to own a house by estimating the diversification benefit of home ownership in a representative investor's portfolio. Similar to holding any financial assets, home ownership may enhance the wealth of a portfolio investor in the form of capital gain, whereas at the same time help diversifying the risk of the overall investment portfolio. If home ownership offers statistically significant enhancement in the risk-return trade off, then it pays to own a house. If a house does not offer such benefit, the case for home ownership is no longer obvious. Perhaps the chapter on "buying versus renting" a house in personal finance textbooks should be approached differently. We advocate an approach where the decisions of home ownership, savings, and investment are made jointly. Therefore, this study broadens the scope of services offered by financial advisors and planners. The common practices for most financial advisors and planners tend to focus exclusively on investments, retirement planning, estate planning, and insurance needs. Residential ownership, which may represent a great part of a household's total wealth, tends to be ignored. This study equips financial advisors or planners to offer a more comprehensive guidance to their clients beyond savings and investment decisions.

The finance literature does address the home ownership decision with the emphasis on the interactions of housing choices with other financial assets. Some researchers examine the ex ante optimality of joint portfolio choices of liquid assets such as stocks, bonds, and the house. Yao and Zhang (2005), for example, derive a stylized model and provide empirical evidence for the ability of the explanatory variables in their model to predict individuals' decisions to own versus to rent a house. Whenever the investor in their model chooses to own a house, the model predicts the investor will reduce the equity proportion in their net worth, reflecting the substitution effect of the house for risky stocks. Flavin and Yamashita (2002) examine the effects of an exogenous housing ownership on the financial portfolio over a life cycle. Unfortunately, in their model, a house is not endogenously included in a household's portfolio based on its risk-return characteristics and, therefore, it cannot address the issue of whether an individual should own a house based on the risk-return characteristics of housing ownership. Hennessey (2003) investigates the home ownership choice using two case studies. His prime focus is the payoff from the ownership without explicitly taking into consideration the risk dimension. Given the importance of risk consideration in modern finance, any analysis without accounting for risk will be incomplete at best. With the exception of Goetzmann (1993) and Wu and Pandey (2012), the existing literature seems to be mostly concerned with the ex ante modeling of the housing choice and the empirical verification of the proposed models. …

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