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Pensions, The Option Value of Work, and Retirement

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  • James H. Stock
  • David A. Wise

Abstract

The paper develops a model of retirement based on the option value of continuing to work. Continuing to work maintains the option of retiring on more advantageous terms later. The model is used to estimate the effects on retirement of firm pension plan provisions. Typical defined benefit pension plans in the United States provide very substantial incentives to remain with the firm until some age, often the early retirement age, and then a strong incentive to leave the firm thereafter. (This may be a major reason for the rapidly declining labor force participation rates of older workers in the United States.) The model fits firm retirement data very well; it captures very closely the sharp discontinuous jumps in retirement rates at specific ages. The model is used to simulate the effect on retirement of potential changes in pension plan provisions. Increasing the age of early retirement from 55 to 60, for example, would reduce firm departure rates between ages 50 and 59 by almost forty percent.

Suggested Citation

  • James H. Stock & David A. Wise, 1988. "Pensions, The Option Value of Work, and Retirement," NBER Working Papers 2686, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:2686
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    1. Berkovec, James & Stern, Steven, 1991. "Job Exit Behavior of Older Men," Econometrica, Econometric Society, vol. 59(1), pages 189-210, January.
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    6. Steven F. Venti & David A. Wise, 1989. "Aging, Moving, and Housing Wealth," NBER Chapters,in: The Economics of Aging, pages 9-54 National Bureau of Economic Research, Inc.
    7. Edward P. Lazear, 1983. "Pensions as Severance Pay," NBER Chapters,in: Financial Aspects of the United States Pension System, pages 57-90 National Bureau of Economic Research, Inc.
    8. Olivia S. Mitchell & Gary S. Fields, 1981. "The Effects of Pensions and Earnings on Retirement: A Review Essay," NBER Working Papers 0772, National Bureau of Economic Research, Inc.
    9. Laurence J. Kotlikoff & David A. Wise, 1985. "Labor Compensation and the Structure of Private Pension Plans: Evidence for Contractual versus Spot Labor Markets," NBER Chapters,in: Pensions, Labor, and Individual Choice, pages 55-88 National Bureau of Economic Research, Inc.
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    11. Douglas W. Phillips & David A. Wise, 1987. "Military versus Civilian Pay: A Descriptive Discussion," NBER Chapters,in: Public Sector Payrolls, pages 19-46 National Bureau of Economic Research, Inc.
    12. Howard L. Frant & Herman B. Leonard, 1987. "Promise Them Anything: The Incentive Structures of Local Public Pension Plans," NBER Chapters,in: Public Sector Payrolls, pages 215-242 National Bureau of Economic Research, Inc.
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    17. repec:hoo:wpaper:e-88-29 is not listed on IDEAS
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