Optimal Portfolio Choice for Early Retirement with Cointegration between the Stock and Labor Markets

We present an optimal portfolio choice for retiring early when a borrowing and short sale constrained investor is facing cointegration between the stock and labor markets. There exists a target wealth-to-income ratio under... [ view full abstract ]

We present an optimal portfolio choice for retiring early when a borrowing and short sale constrained investor is facing cointegration between the stock and labor markets. There exists a target wealth-to-income ratio under which the investor does not invest in stocks, whereas above which she increases the proportion of financial wealth invested in stocks as she accumulates wealth. Contrary to common intuition, flexibility in determining the retirement timing allows the investor to invest less in stocks than without retirement flexibility. The investor’s willingness to retire earlier becomes stronger as risk aversion increases or as wages decline in the long term.