Life-Cycle Consumption, Investment, and Voluntary Retirement with Cointegration between the Stock and Labor Markets
By Min Dai, Shan Huang & Seyoung Park (National University of Singapore)
We present an optimal life-cycle consumption, investment, and voluntary retirement model for a borrowing and short sale constrained investor who faces 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. We analyze the effects on investment of retirement flexibility with and without cointegration. We also isolate the effects on retirement of risk aversion with and without uninsurable income risks. The model presented here predicts that early retirement is economically plausible in the stock market booms, like those observed in the late 1990’s.
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