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In 1989, Mankiw and Weil suggested that the retirement of the Baby Boomer generation would cause a substantial decline in real housing prices. A significant body of literature which both supported and criticised these results followed. Similar issues were also subsequently raised and debated in respect of financial asset prices. The existing literature looks at the impact of demographic aging, as measured by the old-age dependency rate. This thesis extends this literature by accounting for the effects of increasing longevity on both housing and financial asset prices using data for the United States.
Controlling for both longevity and the old-age dependency rate is important because while both contribute to the aging phenomenon, they have opposite effects on household saving, and thus on asset prices. Previous studies have overlooked the longevity effect and as such, their results on the impact of demographic aging on asset prices may be inaccurate. This thesis provides a theoretical framework which sets housing and financial assets as substitutes in demand. An econometric model is derived from the theoretical framework and set up as a vector error correction model. The error correction model accounts for endogeneity between financial asset prices, housing prices, and GDP, and for the possible weak exogeneity of life expectancy and measures of demographic structure. It is found that evidence continues to exist that an increasing old-age dependency ratio has a significantly negative effect on asset prices, and that longevity can have a significantly positive effect, particularly on housing prices. Furthermore, a long-run relationship involving both housing and financial assets is demonstrated, supporting their simultaneous consideration as substitutes.
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