Market Wages, Reservation Wages, and Retirement Decisions

Abstract

The paper is an empirical cross-section of the retirement decisions of American white men between the ages of 58 and 67, predicated on the theoretical notion that an individual retires when his reservation wage exceeds his market wage.Reservation wages are derived from an explicit utility function in which the most critical taste parameter is assumed to vary both systematically and randomly across individuals.Market wages are derived from a standard wage equation adjusted to the special circumstances of older workers.The two equations are estimated jointly by maximum likelihood, which takes into account the potential selectivity bias inherent in the model (low-wage individuals tend to retire and cease reporting their market wage).The model is reasonably successful in predicting retirement decisions and casts serious doubt on previous claims that the social security system induces many workers to retire earlier than they otherwise would.The normal effects of aging (on both market and reservation wages) and the incentives set up by private pension plans are estimated to be major causes of retirement.

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