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Dynamic asset allocation with consumption ratcheting post retirement

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  • Jeon, Junkee
  • Park, Kyunghyun

Abstract

In this paper, we propose a model for optimal consumption/investment and retirement that considers post retirement consumption ratcheting. Specifically, we study a model in which an economic agent has a retirement option and does not tolerate a decline in consumption post retirement. The agent receives a constant labor income but suffers utility loss from the labor before retirement. By considering variational inequality arising from the optimal stopping problem, we derive a closed-form solution for the optimal policies and retirement wealth threshold. We show that this post-retirement spending power raises the optimal retirement wealth threshold, forcing the agent to retire later. By endogenously deriving the initial consumption process at the moment of retirement time, we show that the agent’s consumption flow jumps down at the moment of retirement, which is related to the ``retirement-consumption puzzle''. Moreover, we find that the agent tends to take less risk during his entire lifespan.

Suggested Citation

  • Jeon, Junkee & Park, Kyunghyun, 2020. "Dynamic asset allocation with consumption ratcheting post retirement," Applied Mathematics and Computation, Elsevier, vol. 385(C).
    • Handle: RePEc:eee:apmaco:v:385:y:2020:i:c:s0096300320303799
    DOI: 10.1016/j.amc.2020.125418
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    References listed on IDEAS

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    1. Banks, James & Blundell, Richard & Tanner, Sarah, 1998. "Is There a Retirement-Savings Puzzle?," American Economic Review, American Economic Association, vol. 88(4), pages 769-788, September.
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