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Optimal Consumption and Investment with Cointegrated Stock and Housing Markets

The well-documented nonparticipation in the stock market by many households and the highly negative correlation between stock and housing investment are puzzling. We show that stock and housing markets are cointegrated, and thus households significantly increase housing expenditure, reduce stock investment, and may choose nonparticipation in the stock market at all if they face short-sale constraints. Our model can thus potentially help explain both the puzzle of stock market nonparticipation and the puzzle of the highly negative correlation between stock and housing investment. We also show some empirical evidence that is supportive of the model's main implications.