The effect of housing on portfolio choice

"The NBER Bulletin on Aging and Health provides summaries of publications like this. You can sign up to receive the NBER Bulletin on Aging and Health by email. A large theoretical literature predicts that housing has substantial effects on financial markets, but empirical evidence on these effects remains limited. We estimate the causal effect of changes in mortgages and home equity on portfolio allocations using two empirical strategies. First, we use two instruments -- average house prices in an individual's state in the current year and in the year he purchased his home -- to generate cross-sectional variation in home equity and mortgages that is plausibly orthogonal to unobserved determinants of portfolios. Second, we use panel data to study how portfolio allocations change when individuals buy houses. Both empirical strategies show that housing reduces the amount households invest in stocks substantially: a $10,000 increase in mortgage debt (holding fixed total wealth) reduces the stock share of liquid wealth by approximately 6%. Auxiliary evidence suggests that housing induces individuals to hold more conservative portfolios primarily because of a "consumption commitment" effect rather than exposure to house price risk"--National Bureau of Economic Research web site.