Optimal Retirement Time and Consumption with the Variation in Habitual Persistence

TL;DR

This paper models optimal retirement timing and consumption considering habitual persistence, showing how habits influence retirement decisions and consumption patterns, and explaining the retirement consumption puzzle through a balance of wealth and habitual effects.

Contribution

It introduces a model where habitual levels and sensitivities decline at retirement, providing new insights into optimal retirement and consumption policies using martingale and duality methods.

Findings

Consumption sharply declines at retirement

Excess consumption increases due to reduced habitual sensitivity

Larger wealth delays retirement and increases consumption

Abstract

In this paper,we study the individual's optimal retirement time and optimal consumption under habitual persistence. Because 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 contributes to explain 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.