Optimal Retirement with Long-Run Income Risk
61 Pages Posted: 16 Mar 2017 Last revised: 1 Apr 2022
Date Written: March 14, 2017
We analyze an optimal portfolio problem where an individual receives non-traded labor income and has to decide on her allocation between a stock and a risk-free asset, as well as decide on the time when she goes into retirement. We find that adding long-run income risk modeled as a cointegration between log labor income and log stock price changes the retirement strategy and the optimal risky asset allocation mix. This helps explain the empirical evidence that stock investment increases with retirement age, i.e., individuals who retire early invest less in the stock market. It also helps explain the lack of stock-market participation by young individuals and a risky asset-allocation share that is increasing and concave in wealth.
Keywords: Long-Run Income Risk, Cointegration, Investment, Retirement
JEL Classification: C61, E21, G11
Suggested Citation: Suggested Citation