Human capital and portfolio choice: borrowing constraint and reversible retirement

In this paper, we investigate the impact of the option to retire and subsequently reverse that decision on an individual’s consumption and portfolio decisions. We consider two job status states: the working state, which generates positive labor income, and the retirement state, which generates zero labor income. We find that optimal risky investments are adjusted continuously at retirement, in contrast to previous results where optimal risky investments exhibit large downward jumps in the case of irreversible retirement. Moreover, we show that the optimal retirement threshold is higher in the borrowing-constrained case as compared to the unconstrained case, whereas if retirement is irreversible, the optimal retirement threshold is lower in the constrained case. We also find that risky investments can decrease in financial wealth after retirement if retirement is reversible.