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Spending rules for endowment funds

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  • Isabelle Bajeux-Besnainou

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  • Kurtay Ogunc

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    Abstract

    Endowment fund managers face an asset allocation problem with several particularities: they are more interested in spending for current and future beneficiaries than growing value, although the trade-off between these two alternatives needs to be understood; they have to consider longest-term investment, typically an infinite horizon. We do address these allocation constraints in a dynamic framework where minimum subsistence levels (introducing the idea that a minimum spending amount needs to be made at every time period) are introduced in the objective function. We derive explicit formulas for the optimal spending stream, endowment value, spending rate and portfolio strategy in a simple Black/Scholes type economy. We analyze the effects of parameter changes on asset allocation decisions and provide simulations on bearish, median and bullish paths. Copyright Springer Science + Business Media, LLC 2006

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    File URL: http://hdl.handle.net/10.1007/s11156-006-8544-6
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    Bibliographic Info

    Article provided by Springer in its journal Review of Quantitative Finance and Accounting.

    Volume (Year): 27 (2006)
    Issue (Month): 1 (August)
    Pages: 93-107

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    Handle: RePEc:kap:rqfnac:v:27:y:2006:i:1:p:93-107

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    Web page: http://springerlink.metapress.com/link.asp?id=102990

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    1. Cox, John C. & Huang, Chi-fu, 1989. "Optimal consumption and portfolio policies when asset prices follow a diffusion process," Journal of Economic Theory, Elsevier, vol. 49(1), pages 33-83, October.
    2. Canner, Niko & Mankiw, N Gregory & Weil, David N, 1997. "An Asset Allocation Puzzle," American Economic Review, American Economic Association, vol. 87(1), pages 181-91, March.
    3. Litvack, James M & Malkiel, Burton G & Quandt, Richard E, 1974. "A Plan for the Definition of Endowment Income," American Economic Review, American Economic Association, vol. 64(2), pages 433-37, May.
    4. Isabelle Bajeux-Besnainou & James V. Jordan & Roland Portait, 2001. "An Asset Allocation Puzzle: Comment," American Economic Review, American Economic Association, vol. 91(4), pages 1170-1179, September.
    5. Robert C. Merton, 1993. "Optimal Investment Strategies for University Endowment Funds," NBER Chapters, in: Studies of Supply and Demand in Higher Education, pages 211-242 National Bureau of Economic Research, Inc.
    6. Bodie, Zvi & Merton, Robert C. & Samuelson, William F., 1992. "Labor supply flexibility and portfolio choice in a life cycle model," Journal of Economic Dynamics and Control, Elsevier, vol. 16(3-4), pages 427-449.
    7. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
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