The Impact of the Financial Crisis on Homeowners' Portfolio Choice

Abstract

This paper examines the mediating effect of the recent financial crisis on the relationship between house value fluctuation and households’ liquid portfolio choice. To isolate exogenous variation in homeowners' home equity and mortgage debt before and after the crisis, I use a new regional level construction cost index along with other commonly used house price determinants as instruments. Using an administrative register-based panel data for the entire Danish population in the period 2004 – 2012, I find that the effect of housing on households' risky asset holdings is asymmetric before and after the crisis. The elasticity of risky asset shares with respect to mortgage debt and home equity is -0.31 and 0.28 respectively in pre-crisis period. On the other hand, whereas for the post-crisis period, the elasticity of risky asset shares with respect to mortgage debt and home equity is -0.37 and 0.34 respectively. Suppose an average household had spent 10% more on housing, the estimates suggest that they would hold 6% less in risky shares pre-crisis and 7% less post-crisis. Homeowners rebalance their liquid portfolio to a larger extent in response to their housing value fluctuation after the financial crisis, adding an additional effect that is likely to exacerbate the instability of an already tumultuous financial system.