Lifetime Consumption and Investment: Retirement and Constrained Borrowing
Philip H. Dybvig and Hong Liu

Endogenous choice of when to retire has an interesting impact on optimal portfolio choice and consumption, whether or not it is possible to borrow against labor income. When retirement is voluntary, human capital is negatively correlated with the stock market even when the wage itself is not. This negative correlation implies more stock investment than with a mandatory exogenous retirement date. Portfolio choice can jump down at voluntary retirement; consumption can jump up or down. Inability to borrow limits hedging and reduces the value of labor income, the wealth-to-wage ratio threshold for retirement, and the stock investment. If the wage correlates positively enough with the market, stock investment may start negative and increase over time, even when the risk premium is positive. This contradicts brokers' traditional advice that young investors should be aggressive and older investors should be conservative.