Household Portfolio Choice with Illiquid Assets

The majority of household wealth is held in illiquid forms such as home equity and retirement accounts. This paper presents a theoretical model which derives the optimal portfolio allocation between liquid and illiquid assets. The effect of income uncertainty on portfolio choice behavior is examined in detail. I show that the bulk of household savings can be optimally held in the illiquid form rather than in the liquid form. I also find that the marginal propensity to consume out of liquid resources is larger than the MPC out of illiquid resources especially in the short run. ∗Contact information: Department of Economics, Johns Hopkins University, 3400 N. Charles St., Baltimore, MD 21218. Email: [email protected]. I thank Christopher Carroll, Thomas Lubik, and seminar participants at Johns Hopkins Macro lunch seminars for many helpful comments.