Abstract

http://ssrn.com/abstract=571682
 
 

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Saving and Investing for Early Retirement: A Theoretical Analysis


Emmanuel Farhi


Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Stavros Panageas


University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

January 2005


Abstract:     
We study optimal consumption and portfolio choice in a framework where investors save for early retirement and assume that agents can adjust their labor supply only through an irreversible choice of their retirement time. We obtain closed form solutions and analyze the joint behavior of retirement time, portfolio choice, and consumption. Investing for early retirement tends to increase savings and stock market exposure, and reduce the marginal propensity to consume out of accumulated personal wealth. Contrary to common intuition, prior to retirement an investor might find it optimal to increase the proportion of financial wealth held in stocks as she ages, even when she receives a constant income stream and the investment opportunity set is also constant. This is particularly true when the wealth of the investor increases rapidly due to strong stock market performance, as was the case in the late 1990's. We also show that the model can potentially provide a rational explanation for the paradoxical fact that some investors saving for retirement chose to increase their allocation to stocks as the market was booming and reduce it thereafter.

Number of Pages in PDF File: 68

Keywords: Retirement, Portfolio Choice, Marginal Propensity to Consume, Indivisible Labor

JEL Classification: G0, E2

working papers series


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Date posted: August 2, 2004  

Suggested Citation

Farhi, Emmanuel and Panageas, Stavros, Saving and Investing for Early Retirement: A Theoretical Analysis (January 2005). Available at SSRN: http://ssrn.com/abstract=571682 or http://dx.doi.org/10.2139/ssrn.571682

Contact Information

Emmanuel Farhi
Harvard University - Department of Economics ( email )
1875 Cambridge Street
Cambridge, MA 02138
United States
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Stavros Panageas (Contact Author)
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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