Optimal Consumption and Portfolio Selection with Early Retirement Option

Abstract

In this paper we propose an approach to investigate a model of consumption and investment with a mandatory retirement date and early retirement option; we analyze properties of the optimal strategy and thereby contribute to understanding the interaction between retirement, consumption, and portfolio decisions in the presence of both the important features of retirement. In particular, we provide a characterization of the threshold of wealth as a function of time, and we show that it is strictly decreasing near the mandatory retirement date. The threshold is similar to the early exercise boundary of an American option in the sense that if the agent’s wealth is above or equal to the threshold level, then the agent immediately retires. We also provide comparative static analysis.