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The impact of a partial borrowing limit on financial decisions

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  • Byung Hwa Lim
  • Minsuk Kwak

Abstract

We consider a consumption, investment, life insurance, and retirement decision problem in which an economic agent is allowed to borrow against only a part of future income. The closed-form solution is attained by applying a dual approach that directly imposes the conditions for the borrowing limit on a dual value function. We provide analytic comparative statics for optimal strategies with rigorous proofs. It is confirmed that a more stringent borrowing limit leads to less consumption and less life insurance purchase. However, even with a tighter borrowing limit, an agent with weak incentive to retire can invest more when the wealth level is high enough. We also show that a more stringent borrowing limit can delay or hasten the optimal retirement timing depending on the agent's current wealth level.

Suggested Citation

  • Byung Hwa Lim & Minsuk Kwak, 2019. "The impact of a partial borrowing limit on financial decisions," Quantitative Finance, Taylor & Francis Journals, vol. 19(5), pages 859-883, May.
    • Handle: RePEc:taf:quantf:v:19:y:2019:i:5:p:859-883
    DOI: 10.1080/14697688.2018.1526395
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    Cited by:

    1. Ding, Guodong & Marazzina, Daniele, 2022. "The impact of liquidity constraints and cashflows on the optimal retirement problem," Finance Research Letters, Elsevier, vol. 49(C).

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