On retirement time decision making (Q2234755)

In this paper, the authors investigate an optimal retirement problem by considering three types of individuals, namely a pre-committed individual, a naïve individual and a sophisticated individual. Two key factors impacting retirement decision-making, say market factors and mortality factors, are considered. Both a deterministic economy and a stochastic economy are studied. The authors show that in the deterministic economy, the three types of individuals make the same decision on the optimal retirement time. In the case of a stochastic economy, they reach the conclusion that when making optimal retirement decisions, young individuals give priority to market factors, while older individuals focus on mortality factors. Section 2 of the paper formulates optimal retirement problems for the three types of individuals. It is supposed that the financial and mortality risks are independent and that preferences for the three types of individuals are described by a power utility function. The decision variables for each of the individuals are retirement time and consumption. In Section 3, the optimal retirement problem of the three types of individuals is discussed in a deterministic economy. It is assumed that the economy consists of a risk-free asset with a constant risk-free rate and that an individual receives a continuous stream of constant income before retirement. The wealth dynamics of an individual are derived based on the assumption that the individual can short-sell life insurance products. It is also supposed that the individual is allowed to borrow against the future labour income. Proposition 3.1 gives the optimal consumption and wealth of the pre-committed individual given the optimal retirement time in the deterministic economy. From Proposition 3.1, an optimal retirement time of the pre-committed individual is also determined. To characterize the optimal retirement time, Lemma 3.2 giving certain properties of the value function is provided. Proposition 3.3 presents an optimal consumption and wealth of the naïve individual. The ultimate retirement time of the naïve individual is then determined accordingly. Theorems 3.4--3.5 and Corollary 3.6 give the result that under the assumptions that the subjective discount rate is less than or equal to the risk-free rate and that the force of morality is age-dependent, the three types of individuals agree on the optimal retirement time as well as on the optimal consumption and wealth in the deterministic economy. Section 4 discusses the optimal retirement problem of the three types of individuals in a stochastic economy, where a financial market consists of a risk-free asset and a risky asset whose price dynamics are governed by a geometric Brownian motion. It is supposed that before retirement, individuals receive stochastic labour income whose dynamics are governed by another geometric Brownian motion. The choice variables of an individual are optimal retirement time, consumption, investment. The possibility of short-selling life insurance products is incorporated into the wealth dynamics of an individual. The optimal control problem of the three types of individuals is discussed using the martingale approach by \textit{I. Karatzas} et al. [SIAM J. Control Optim. 25, 1557--1586 (1987; Zbl 0644.93066)] and \textit{J. C. Cox} and \textit{C.-f. Huang} [J. Econ. Theory 49, No. 1, 33--83 (1989; Zbl 0678.90011)] with the state-price density in [\textit{P. H. Dybvig} and \textit{H. Liu}, J. Econ. Theory 145, No. 3, 885--907 (2010; Zbl 1245.91044)]. The optimization results of the pre-committed individual, the naïve individual and the sophisticated individual are presented in Propositions 4.1, 4.2 and 4.3, respectively. Numerical analyses to compare retirement decisions are presented in Section 5. Specifically, the welfare loss between two individuals is quantified. Sensitivity analyses for different ages, preferences, standard deviations of the labour income process are conducted. Further discussion on the impact of additional retirement income is provided in Section 6.