During the last decades households in the U.S. have experienced that residential house prices move in a persistent manner, i.e. that returns are positively serially correlated. Since an owner-occupied home is usually the largest investment of a household it is important to understand how households act when they base their consumption and investment decisions on this experience. We show in a setting with housing market cycles and households who can decide whether they rent or own the home, that-besides the consumption and the precautionary savings motive-serial correlation in house prices generates a new speculative motive for homeownership. In particular, we show how good and bad housing market cycles affect homeownership rates, leverage, stock investments and consumption and can explain empirically observed household behavior during housing market boom and bust periods.

Taxation, transfer income and stock market participation This article studies the impact of taxing investment returns to finance wealth transfers from richer to poorer investors in a general equilibrium model with heterogeneous agents. Since the level of tax revenues depends on the evolution of the stock market, the level of the wealth transfer also depends on the evolution of the stock market. As a consequence, recipients of transfer income are subject to stock market risk through the transfer mechanism. As a consequence, it can be optimal for them not to further engage in the stock market. In particular, transfer income can thereby help understanding the low empirically documented stock market participation rates of poorer investors.

We study the out-of-sample performance of portfolio trading strategies when an investor faces capital gain taxation and proportional transaction costs. Overlaying simple tax trading heuristics on trading strategies improves out-of-sample performance. For medium to large transaction costs, no trading strategy can outperform a 1/N trading strategy augmented with a tax heuristic, not even the most tax-and transaction-cost efficient buy-and-hold strategy. Overall, the best strategy is 1/N augmented with a heuristic that allows for a fixed deviation in absolute portfolio weights. Our results thus show that the best trading strategies balance diversification considerations and tax considerations.

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