Optimal Retirement and Portfolio Selection with Consumption Ratcheting
43 Pages Posted: 29 Oct 2019
Date Written: October 13, 2019
The purpose of this paper is to study the optimal retirement and consumption/investment decisions of an infinitely lived agent who does not tolerate any decline in her consumption throughout her lifetime. The agent receives labor income but suffers disutility from working until retirement. The agent’s optimization problem combines features of both singular control and optimal stopping. We use the martingale method and study the dual problem, which can be decoupled into a singular control problem and an optimal stopping problem. We provide a closed-form solution of the optimal strategies for the time-separable von-Neumann-Morgenstern utility function. We show that the coefficient of relative risk aversion implied by the optimal portfolio (i.e., the implied coefficient of relative risk aversion, ICRRA) is a constant value smaller than 1. Moreover, we show that the ICRRA is independent of the agent's felicity utility function and depends only on the subjective discount rate and market parameters.
Keywords: Portfolio selection, Consumption ratcheting, Early retirement option, Singular control problem, Optimal stopping problem
JEL Classification: E21, G11
Suggested Citation: Suggested Citation