Pensions, the Option Value of Work, and Retirement

54 Pages Posted: 25 Jun 2004 Last revised: 5 Nov 2022

See all articles by James H. Stock

James H. Stock

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

David A. Wise

National Bureau of Economic Research (NBER); Harvard University - Harvard Kennedy School (HKS)

Date Written: August 1988

Abstract

The paper develops a model of retirement based on the option value of continuing to work. Continuing to work maintains the option of retiring on more advantageous terms later. The model is used to estimate the effects on retirement of firm pension plan provisions. Typical defined benefit pension plans in the United States provide very substantial incentives to remain with the firm until some age, often the early retirement age, and then a strong incentive to leave the firm thereafter. (This may be a major reason for the rapidly declining labor force participation rates of older workers in the United States.) The model fits firm retirement data very well; it captures very closely the sharp discontinuous jumps in retirement rates at specific ages. The model is used to simulate the effect on retirement of potential changes in pension plan provisions. Increasing the age of early retirement from 55 to 60, for example, would reduce firm departure rates between ages 50 and 59 by almost forty percent.

Suggested Citation

Stock, James H. and Wise, David A., Pensions, the Option Value of Work, and Retirement (August 1988). NBER Working Paper No. w2686, Available at SSRN: https://ssrn.com/abstract=439603

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David A. Wise

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Harvard University - Harvard Kennedy School (HKS)

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