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Optimal asset allocation, consumption and retirement time with the variation in habitual persistence

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  • He, Lin
  • Liang, Zongxia
  • Song, Yilun
  • Ye, Qi

Abstract

In this paper, we study the individual's optimal asset allocation, consumption and retirement time under habitual persistence. To depict the phenomenon that the individual feels equally satisfied with a lower habitual level and is more reluctant to change the habitual level after retirement, we assume that both the level and the sensitivity of the habitual consumption decline at the time of retirement. We establish the concise form of the habitual evolutions, and obtain the optimal retirement time and consumption policy based on martingale and duality methods. The optimal consumption experiences a sharp decline at retirement, but the excess consumption raises because of the reduced sensitivity of the habitual level. This result is consistent with the evidence observed in the “retirement consumption puzzle”. Particularly, the optimal retirement and consumption policies are balanced between the wealth effect and the habitual effect. Larger wealth increases consumption, and larger growth inertia (sensitivity) of the habitual level decreases consumption and brings forward the retirement time.

Suggested Citation

  • He, Lin & Liang, Zongxia & Song, Yilun & Ye, Qi, 2022. "Optimal asset allocation, consumption and retirement time with the variation in habitual persistence," Insurance: Mathematics and Economics, Elsevier, vol. 102(C), pages 188-202.
  • Handle: RePEc:eee:insuma:v:102:y:2022:i:c:p:188-202
    DOI: 10.1016/j.insmatheco.2021.10.004
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    More about this item

    Keywords

    Optimal retirement time; Retirement consumption puzzle; Habitual persistence; Optimal consumption; Martingale and duality methods;
    All these keywords.

    JEL classification:

    • G22 - Financial Economics - - Financial Institutions and Services - - - Insurance; Insurance Companies; Actuarial Studies
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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