1. Efficient portfolios when housing is a hedge against rent risk ► Housing is a big part of household portfolios ► What does this mean for optimal portfolio allocation of financial assets? ► What role can housing wealth play in financing retirement? Age Housing wealth (net of mortgage) Financial assets < 40 £57,000£7,500 40 – 59 £100,000£28,500 60 + £110,000£37,000 UK, BHPS 2000, mean values (>0) Banks, Blundell & Smith

2. Houses aren’t like other assets Investment: asset in wealth portfolio Consumption: flow of housing services Consumption: utility from home-ownership Hedge against rent risk (Souleles & Sinai) Hedge against house price risk (Banks et al) Bequest

3. The model ► Exogenously-determined demand for housing services + optimal decision to rent or buy  given level of housing wealth ► What does this do to optimal holdings of other financial assets? ► Hedge term –H Cov(r r r h )/ Var(r r ) ► For Italy, negative correlation between returns to housing and returns to shares implies greater holdings of shares for people with positive housing wealth

4. The model ► Housing is a hedge against rent risk ► H = (Value of house) – PDV(future_rent) ► Dramatically reduces estimated housing wealth (on average) ► Gross housing wealth = 200 000; net = 11 000 ► Financial wealth = 44 109 ► Human capital (incl DB pension) = 656 707 ► Young are typically short on housing wealth ► Old are more likely to be long on housing wealth  but role as hedge reduces incentive to sell, particularly for a group for whom the cost of rent risk is fairly high

5. The results ► Compare actual portfolios with efficient frontier ► Around half Italians have “efficient” portfolios ► More likely to be “efficient”:  negligible housing wealth, South, middle-aged, higher financial wealth, less-well educated ► What does this mean? ► Moving the inefficient towards more efficient portfolios?  information, education, barriers to holding particular financial instruments (tax treatment, costs), financial instruments ► Is the “efficiency” benchmark the right one?  Housing as a hedge, but different numbers/ assumptions  Housing as something else

6. What is an efficient portfolio? ► Housing as a hedge, but look at some of the numbers/ assumptions: ► Demand for future housing is uncertain – and endogenous ► House price risk (assumption of perfect correlation)  Idiosyncratic house price risk > market average  Idiosyncratic rent risk < market average  Rent risk affected by benefit system ► How do Italians finance house purchase?  Fewer & smaller mortgages, more saving – want to save in assets whose returns are positively correlated with house prices

7. What is an efficient portfolio? ► How do people view housing in their portfolios? ► Highest proportion of efficient portfolios occur where there is negligible housing wealth → c omparing with benchmark with no housing wealth considerations would yield higher proportion of “efficient” portfolios ► Bequest motive? ► Human capital  Why risk-free? Particularly risky for the young  Level, and risk, likely to affect decision to rent/ buy  Implications of including human capital for efficient portfolios, and optimal pension arrangements