Standard tests of portfolio efficiency neglect the existence of illiquid wealth. The most important illiquid asset in household portfolios is housing: if housing stock adjustments are infrequent, optimal portfolios in periods of no adjustment are affected by housing price risk through a hedge term and tests for portfolio efficiency of financial assets must be run conditionally upon housing wealth. We use Italian household portfolio data and time series on financial assets and housing stock returns to assess whether actual portfolios are efficient. We find that housing wealth plays a key role in determining whether portfolios chosen by homeowners are efficient.
* Pelizzon, email@example.com, University of Venice and SSAV, Dipartimento di Scienze Economiche, University Ca' Foscari of Venice, Fondamenta San Giobbe 873, 30121 Venezia, Italy; Weber, firstname.lastname@example.org, University of Padua, IFS, and CEPR, Dipartimento di Scienze Economiche, University of Padua, Via del Santo, 33, 35123 Padova, Italy. We are grateful to Elena Parcianello and Viola Angelini for skillful research assistance and to Alessandro Bucciol, Marjorie Flavin, William Goetzmann, Elisa Luciano, Raffaele Miniaci, Giovanna Nicodano, Marco Pagano, Stephen Schaefer, and BasWerker for helpful discussions. We are also grateful for comments made by Paul Malatesta (the editor) and Andrey Pavlov (the referee), as well as by audiences at CSEF (Salerno), University of Padua, University of Turin, the 2003 Western Financial Association, European Financial Management Association, European Financial Association conferences, and the Tilburg 2005 Netspar Ageing conference. This research was partly financed by MIUR and CNR. An earlier version of this paper was circulated as CEPR DP 3890.