Optimal Portfolio Choice for Early Retirement with Cointegration between the Stock and Labor Markets
61 Pages Posted: 16 Mar 2017 Last revised: 15 Nov 2017
Date Written: March 14, 2017
We present an optimal portfolio choice for retiring early when a borrowing and short sale constrained investor is facing cointegration between the stock and labor markets. With reasonable parameter values, there exists a target wealth-to-income ratio under which the investor does not participate in the stock market at all, whereas above which the investor increases the proportion of financial wealth invested in the stock market as she accumulates wealth. Contrary to common intuition, flexibility in determining the retirement timing allows the investor to invest less in the stock market than without retirement flexibility. Finally, the investor's willingness to retire earlier becomes stronger as risk aversion increases or as wages decline in the long term.
Keywords: Optimal Consumption, Optimal Investment, Retirement, Cointegration, Income Risks
JEL Classification: C61, E21, G11
Suggested Citation: Suggested Citation