Estimating Life-Cycle Parameters from Consumption Behavior at Retirement

Abstract

Using pseudo-panel data, we estimate the structural parameters of a life-cycle consumption model with discrete labor supply choice. A focus of our analysis is the abrupt drop in consumption upon retirement for a typical household. The literature sometimes refers to the drop, which in the U.S. Consumer Expenditure Survey we estimate to be approximately 16%, as the "retirement-consumption puzzle." Although a downward step in consumption at retirement contradicts predictions from life-cycle models with additively separable consumption and leisure, or with continuous work-hour options, a consumption jump is consistent with a setup having nonseparable preferences over consumption and leisure and requiring discrete work choices. This paper specifies a life-cycle model with these latter two elements, and it uses the empirical magnitude of the drop in consumption at retirement to provide an advantageous method of identifying structural parameters-most importantly, the intertemporal elasticity of substitution.