Seminars

Forced Retirement Risk and Portfolio Choice

The literature on the effect of labor income on portfolio choice fails to consider that workers face a risk of being forced to retire before their planned retirement age. Using data from the Health and Retirement Studies, this paper finds the forced retirement risk to be significant and also highly correlated with stock market fluctuations. A life-cycle portfolio choice model with the estimated forced retirement risk shows that labor income subjects to the forced retirement risk becomes stock-like as individuals approach their retirement. Therefore, contrary to the conventional wisdom, those who are still working but close to retirement should have a lower share of risky assets in their financial portfolios than retirees do. Given that most of financial assets are held by middle-aged households, this finding gives an alternative explanation to the risk premium puzzle.