Portfolio Choice with House Value Misperception Portfolio Choice with House Value Misperception

By Stefano Corradin, José L. Fillat, and Carles Vergara-Alert

For the majority of households that own their primary residence, this home is their most important asset—it serves as a vehicle for savings and investment while also conferring shelter services. The house’s current value serves as a key determinant of the household’s other portfolio choices, as well as decisions related to consumption, savings, and retirement planning. By using data on self-reported (subjective) house values taken from individual households that participate in the Panel Study of Income Dynamics (PSID), and comparing this information to the zip code-level Core Logic Home Price Index, used as a proxy for the house’s market (objective) value, the authors show that over the 1984–2013 period, about half of the US households in this PSID sample systematically miscalculated the true current value of their home. Twenty-five percent of these households undervalued their house by 11 percent or more, while 25 percent overvalued their homes by at least 9 percent. Most studies on individual portfolio choice assume that households have accurate knowledge of their house’s market value, and thus do not consider how inaccurate beliefs about house values may skew other portfolio choices. By accounting for house value misperception and the role it may play in the household’s other financial decisions, the authors extend the portfolio choice model with transaction costs proposed in Grossman and Laroque (1990) and extend Alvarez, Guiso, and Lippi (2012) by incorporating uncertainty in the price of housing (a durable good) as it relates to choices for both housing and nonhousing consumption.

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