An Intertemporal Capital Asset Pricing Model with Owner‐Occupied Housing

This article studies portfolio choice and asset pricing in the presence of owner‐occupied housing in a continuous time framework. The unique feature of the model is that housing is a consumption good as well as a risky asset. Under general conditions, that is, when the utility function is not Cobb–Douglas and the covariance matrix is not block‐diagonal, the model shows that the market portfolio is not mean‐variance efficient, and the traditional capital asset pricing model fails. Nonetheless, a conditional linear factor pricing model holds with housing return and market portfolio return as two risk factors. The model also predicts that the nondurable consumption‐to‐housing ratio (ch) can forecast financial asset returns. The two factor pricing model conditioning on ch yields a good cross‐sectional fit for Fama–French 25 portfolios.