Misestimating House Values: Consequences for Household Finance 
The literature on portfolio choice that incorporates housing typically assumes that households accurately observe house prices. However, the authors of this paper find that a considerable share of homeowners either undervalue or overvalue their house by a sizable amount. The authors develop a simple theoretical framework to show the implications of incorporating house-value misestimation in the analysis of household portfolio and consumption decisions. They then use household-level data to estimate the effects of misestimation on those decisions.
Key Findings
- About 5 percent of homeowners undervalue their house by at least $87,500, and 5 percent overvalue their house by at least $53,000.
- A $59,800 increase in house overvaluation, which represents one standard deviation, results, on average, in a 1.1 to 1.9 percent decrease in a household’s risky stockholdings.
- The same increase in house overvaluation results in a 1.3 to 2.5 percent increase over liquid wealth in the share of a household’s assets that are risk free, holding house value and mortgage debt constant.
- In addition, the increase in overvaluation leads to a 1.5 to 4.3 percent (or 2.63 to 4.31 percentage point) increase in a household’s consumption relative to its liquid wealth.
Implications
The findings underscore the role of housing-value misestimation in the marginal propensity to consume, suggesting that households adjust their spending behavior in response to perceived, in addition to actual, wealth gains. Additionally, the findings show that households with higher perceived house values tend to reallocate financial assets away from stocks toward risk-free assets, reinforcing a conservative shift in their financial portfolio composition. These results suggest that financial advisors and policymakers should account for biases in housing wealth perceptions when designing investment and retirement strategies. In addition, given the widespread use of home equity as collateral, the findings imply that misestimation of house values could have significant implications for credit availability and macroeconomic stability.
Abstract
This study examines the effect of systematic household misestimation of home prices on financial decisions, including stockholdings, consumption, and asset allocation. Using exogenous variation in house values, mortgage debt, and homeowner misestimation identified through differences in local housing market characteristics, we find that a $60,000 increase in house overvaluation (approximately one standard deviation) results in a 1.1 to 1.9 percent decrease in risky stockholdings, a 1.5 to 4.3 percent increase in consumption, and a 1.3 to 2.5 percent increase in the share of risk-free assets over liquid wealth. The results highlight the need to better understand how housing wealth and beliefs about house values affect portfolio choice, spending, and overall household finance.