Optimal Life-Cycle Asset Allocation with Housing as Collateral

We investigate a household’s asset allocation, housing, and mortgage decisions in a calibrated life-cycle model with costly stock market entry and participation and a risky housing market featuring housing adjustment costs, mortgage collateral borrowing requirement, refinancing charge, and default penalty. Our analysis demonstrates that a household’s liquid wealth is the most important determinant of both home and stock ownership. Our model can generate empirically documented hump-shaped life–cycle home and stock ownership patterns as well as explaining the negative (positive) effect of housing (mortgage) position on stock market participation and overall equity exposure. Extensive comparative static analysis suggests that ignoring mortgage refinancing cost and default option introduces significant biases in stock market participation rates and overall stockholdings.