Effects of a government subsidy and labor flexibility on portfolio selection and retirement

Abstract

We address the ways in which a government subsidy and labor flexibility affect optimal policies and retirement decisions using a continuous-time theoretical model with endogenous labor/leisure choice. In response to a government subsidy, working agents increase their overall consumption, leisure spending, and investment in risky assets, which is an intuitive finding. Labor flexibility has marginal effects on consumption and leisure when an agent's wealth is insufficient. However, when a working agent has enough wealth to enjoy maximum leisure, labor flexibility increases leisure spending and reduces risky investments. The impacts of the two features conflict in terms of retirement decisions (i.e. the optimal threshold wealth level is decreased by the subsidy and increased by labor welfare), while labor flexibility takes precedence. Furthermore, the government subsidy is more impactful in a bad economy than in a good economy.