HOUSING DECISION WITH DIVORCE RISK

• Author: Marcel Fischer,Natalia Khorunzhina
• Published date: 01 August 2019
• DOI: http://doi.org/10.1111/iere.12385
• Date: 01 August 2019

INTERNATIONAL ECONOMIC REVIEW

Vol. 60, No. 3, August 2019 DOI: 10.1111/iere.12385

HOUSING DECISION WITH DIVORCE RISK∗

BYMARCEL FISCHER AND NATALIA KHORUNZHINA1

University of Konstanz, Germany, Copenhagen Business School,Denmark; Copenhagen

Business School, Denmark

We build a life-cycle model of housing decisions under divorce risk that predicts that the recent increase in

divorcerates leads to reduced homeownership rates. The risk of a divorce triggers a precautionary-savings motive.

However, this motive is weaker when individuals can invest in owner-occupied homes because homeowners’

higher savings partially substitute for precautionary savings. When young, the larger asset accumulation due

to divorce-risk-induced precautionary savings enables households to buy homes earlier, whereas the presence

of transaction costs leads to reduced homeownership for middle-aged and older households when divorce risk

goes up.

1. INTRODUCTION

Since the 1970s, the share of the divorced population in the United States has been on the

rise, leveling off during the 1990s, and remaining at a high level during the 2000s. According to

the U.S. Census Bureau, in 1970, only 6% of women aged 15 years and above were divorced or

separated, whereas by 2000, their share more than doubled, reaching 13% (Fields and Casper,

2001). Over the same period, homeownership rates declined for the working-age cohorts of

the population (Fisher and Gervais, 2011; Goodman et al., 2015). Owner-occupied homes can

be viewed as a consumption commitment that involves substantial transaction costs at trading

(Chetty and Szeidl, 2007). As the risk of divorce increases, households may be reluctant to

expose themselves to the prospect of an untimely sale of their marital home and shy away from

homeownership. A negative correlation between homeownership and divorce rates observed in

the data is suggestive of this reluctance. An owner-occupied home is the largest single financial

asset for the majority of households. Nevertheless, the implications of divorce risk for housing

and homeownership have received little attention in the literature. In this article, we investigate

the impact of divorce risk on housing decisions of households.

To investigate the mechanism of divorce risk on housing, we construct a life-cycle model of

consumption, investment, and housing decisions, and calibrate it to micro- and macroevidence.

Our model shows that an increase in divorce rates can explain the reduction in homeownership,

∗Manuscript received April 2016; revised November 2018.

1We would like to thank Mario Crucini, Moira Daly, Marco Della Seta, James Feigenbaum, Grey Gordon, Nadia

Greenhalgh-Stanley, Fane Naja Groes, Georgi Kocharkov, Weicheng Lian, David Love, Jimmy Martinez Correa, Mas-

simo Massa, Dominik Menno, Alvaro Mezza, Robert Miller, Alvin Murphy, Andrey Pavlov, Mauricio Prado, Jesper

Rangvid, Holger Sieg, Steffen Sebastian, Ramona Westermann, and seminar participants at Copenhagen Business

School, the Universities of Aachen, Dortmund, Hannover, Konstanz, and Regensburg, as well as the Midwest Macro

Meeting, the American Real Estate and Urban Economics Association Meeting, the Arne Ryde Workshop at Lund

University, the IREBS Conference, the SGF Conference, the ECD Conference, the ReCapNet Conference, the Christ-

mas Meeting of German Economists abroad, and the German Finance Association Annual Meeting for discussions and

insightful comments. We thank Dirk Krueger (the associate editor) and three anonymous referees for their comments,

which helped us improve the article. Marcel Fischer gratefully acknowledges financial support from the Household

Economics and Finance research initiative at Copenhagen Business School and German Research Association (DFG),

grant FI2141/1-1. All errors are our own. Please address correspondence to: Natalia Khorunzhina, Department of

Economics, Copenhagen Business School, Porcelaenshaven 16 A, DK-2000 Frederiksberg, Denmark (DK). Phone:

+45 3815 2403, Fax: +45 3815 2576. E-mail: nk.eco@cbs.dk

1263

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(2019) by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social

and Economic Research Association

1264 FISCHER AND KHORUNZHINA

observed in the data. Our model predicts that the event of a divorce leads to a long-lasting

reduction in homeownership rates. The risk of divorce triggers a precautionary-savings motive

and results in higher net worth, which can speed up the transition to homeownership. The

precautionary savings channel can be counteracted by the reluctance to incur sizable transaction

costs associated with trading homes when the sale of the marital home is inevitable at divorce.

We find that under the risk of divorce, precautionary savings enable young households to

buy homes earlier, whereas the forfeiture of transaction costs upon divorce results in lower

homeownership rates for middle-aged and older households.

In our model, gender, marital status, and the number and ages of children characterize the

family structure of households. We distinguish between single and married households and allow

households’ marital status to change over time. During their fecund period, females can give

birth to children. Homeownership is strongly desired by households with children ( ¨

Ost, 2012),

which our model addresses by allowing households with children to have a greater preference

for living in an owner-occupied home. In the spirit of Cubeddu and R`

ıos-Rull (2003), marital

status and fertility are treated as shocks, which are conditional on gender, age, and education.

Fertility further depends on marital status, whereas divorce depends on the presence of children

in the household. Mortality rates determine the transition to widowhood and out of population

through death. Our comprehensive treatment of transitions in family structure is an extension

of life-cycle models with housing of Cocco (2005) and Yao and Zhang (2005). Another study

related to our model is Love (2010), who focuses on how family structure affects savings and

asset allocation, but abstracts away from housing decisions.

Households live in an environment of uncertain formation of economic resources, such as

risky returns on real estate and uninsurable income risk. As in Cocco (2005), shocks to labor

income and house prices are positively correlated. Married individuals are subject to lower

income volatility and are therefore less sensitive to unfavorable income shocks. Lower income

risk for married households combined with its positive correlation with house-price risk makes

homeownership less risky for married households and hence more attractive.2Economies of

scale enable married couples to save faster and buy homes earlier.

Our model predicts that divorces decrease the demand for homeownership. This finding is

consistent with the empirical analysis that we conduct using various data and different levels

of aggregation from individual to aggregated regional data. In our model, the drop in home-

ownership is mainly driven by three effects. First, divorce instantly implies a sharp drop in

household net worth due to the splitting of assets and the cost of divorce. Second, the newly

divorced individual cannot take full advantage of the economies of scale. Third, the new single’s

income is subject to a higher volatility than the former couple’s. Higher income risk for divorced

households combined with its correlation with house-price risk makes homeownership riskier

for divorced households, and hence less attractive.

Cubeddu and R`

ıos-Rull (2003), Fern´

andez and Wong (2014), and Voena (2015) show that

higher divorce risk results in increased savings for married couples. Likewise, we find that

divorce risk triggers the precautionary-savings motive. When divorce risk is high, individuals

save more to smooth the possible transition to a less economically favorable post-divorce state.

We compare net worth accumulation in a model with owner-occupied homes to net worth

accumulation in a model without homeownership, and we draw two conclusions. First, the dual

role of owner-occupied homes as both consumption and investment goods makes investment

in owner-occupied homes attractive and leads to generally higher levels of net worth than for

households that cannot acquire owner-occupied homes. Second, the opportunity to invest in

owner-occupied homes weakens the precautionary-savings motive, because the higher savings

of homeowners substitute for precautionary savings.

2Bertocchi et al. (2011), considering marriage as a sort of safe asset, show that married individuals have a higher

propensity to invest in risky assets. Similarly, risky housing in our model is more attractive to married households

because of the implicit spousal insurance, resulting in lower income risk.