Household Finance in Developing Countries: Evidence from India

Abstract

This paper studies how adjustment costs in real estate investments affect portfolio choices of developing economy households. Using novel panel data on Indian households, we document that while most households hold outstanding investments in real estate, the majority of them participated exclusively in financial assets during the five year survey period. We explain these stylized facts by identifying how households allocate their marginal income across various assets. Using local rainfall shocks as a source exogenous variation in household incomes, we empirically establish the presence of adjustment costs in real estate, which drives the infrequent participation of households in this asset class. We further show that the households use financial assets as a transitory asset class on their way to accumulating real estate. Our results are consistent with a theoretical model of portfolio choice where households face an adjustment cost to re-adjust their lumpy real estate holdings.

Keywords: Household Finance, Portfolio Choice, Financial vs. Physical Assets, Adjustment Costs

JEL Classification: D14, D15, O16