Consumption, investment, life insurance, and early retirement decisions under habit-dependent living standards

Abstract

This paper studies the optimal strategies for consumption, investment, and life insurance purchase, as well as the early retirement decision, of an economic agent with a consumption habit dependent on their historical maximum living standard. We show that the agent’s optimal consumption varies between the lowest tolerable level and the habit level unless the accumulated financial wealth reaches an adjustment level. However, consumption tends to increase with sufficient wealth to reach this adjustment level. We also show that agents who are less tolerant of declines in living standards tend to retire later. The results of risky investments are also consistent with empirical findings that investigate the risk-taking behavior of individuals.