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Essays in asset pricing and real estate

Yu Zhang, 2008
Faculty Advisor: Christopher Mayer
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The first chapter of this dissertation introduces housing as a hedging asset in a life-cycle portfolio choice model and addresses the empirically documented hump-shaped life-cycle stock investment pattern. I show that the life-cycle pattern of housing investment has a crucial influence on investments in stocks. House tenure choice is endogenized and an investor uses housing investment to hedge against both labor income risk and rent risk when labor income, house price, rent, and stock price co-vary with each other. The "U-shaped" life-cycle housing investment profile helps to explain the equity allocation puzzle. This paper also demonstrates that optimal portfolio choice varies across local housing markets and industries, so that a one-size-fits-all prescription is unsuitable for life-cycle investments.

The second chapter explores the portfolio choice in a multi-asset setting. It considers a more realistic portfolio which contains not only financial assets but also housing investment and human capital. I look at the covariance structure of labor income, house price, rent, and stock price and examine the possibility of households using these multiple assets in hedging. I obtained the data of these four time series and computed the correlations and volatilities over the period 1980 and 2004. In addition, the PSID data with its Geocode data are used to conduct cross-sectional portfolio choice analysis. I find evidence that the PSID households use housing investment to hedge against labor income risk and rent risk, consistent with the findings by Davidoff (2006) and Sinai and Souleles (2005) and in the real estate literature.

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