The impact of the minimum housing scale constraint on life-cycle risky asset and housing investment

Abstract

While the standard loan-to-value (LTV) and loan-to-income (LTI) mortgage borrowing constraints are widely studied in the theoretical housing demand literature, the way they interact with the minimum housing scale (MHS) constraint to determine life-cycle choices has received far less attention. We adopt a stochastic partial equilibrium life-cycle model within which consumers choose a portfolio of three assets, subject to standard LTV and LTI constraints, as well as an MHS. We highlight features of possible solutions involving different binding constraints each period. Moreover, we provide closed-form solutions and simulated life time paths for different realisations of uncertainty with Stone-Geary preferences. Our simulation results show that the MHS constraint generates an increasing profile of risky asset share profile in the presence of mortgage constraints, and imply that the MHS may worsen poor people’s welfare by crowding them out of home ownership for a longer period of their life-time and exacerbate the wealth inequality both in risky asset and housing wealth in the long run.