Optimal Consumption and Portfolio Choice in the Presence of Risky House Prices

This paper explores optimal consumption and portfolio decisions in the presence of risky house prices. We assume that changes in real interest rates and future rents directly impact house prices. A novel aspect of our model is that rent inflation rates and consumption inflation rates are cointegrated. We show that the individual prefers to be a home owner when young and a renter when old. This motives the design of so-called reverse mortgage products. Furthermore, she invests significantly less pension wealth in inflation-linked bonds, as compared to conventional wisdom. Finally, we find that the optimal mortgage changes from fixed-rate to adjustable-rate as the individual becomes older.