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Scenario Analysis With Recursive Utility: Dynamic Consumption Plans For Charitable Endowments

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Stephen Satchell ()
Susan Thorp ()

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Abstract

We determine optimal consumption paths under a series of returns scenarios for charitable endowments with distinct tastes over investment risk and inter-temporal substitution. Charities typically prefer smooth consumption paths but are investment-risk tolerant. Using a recursive, Kreps-Porteus utility function, we model the optimal disbursement from an infinitely-lived charitable trust, then, allowing a general form for the returns density, we apply stochastic dominance relations to estimate income/substitution effects whereby a change in future returns influences the current consumption rate. The elasticity of intertemporal substitution rather than risk aversion is key: optimal consumption rises or falls as the elasticity diverges from one.

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Paper provided by Australian National University, Centre for Applied Macroeconomic Analysis in its series CAMA Working Papers with number 2008-03.

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Length: 52 pages
Date of creation: Jan 2008
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Handle: RePEc:acb:camaaa:2008-03

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Find related papers by JEL classification:
G00 - Financial Economics - - General - - - General
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving

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  2. Jorion, Philippe & Giovannini, Alberto, 1993. "Time-series tests of a non-expected-utility model of asset pricing," European Economic Review, Elsevier, vol. 37(5), pages 1083-1100, June. [Downloadable!] (restricted)
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  3. Nichols, Donald A, 1974. "The Investment Income Formula of the American Economic Association," American Economic Review, American Economic Association, vol. 64(2), pages 420-26, May. [Downloadable!] (restricted)
  4. Smith, William T., 1996. "Feasibility and transversality conditions for models of portfolio choice with non-expected utility in continuous time," Economics Letters, Elsevier, vol. 53(2), pages 123-131, November. [Downloadable!] (restricted)
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  6. Tobin, James, 1974. "What Is Permanent Endowment Income?," American Economic Review, American Economic Association, vol. 64(2), pages 427-32, May. [Downloadable!] (restricted)
  7. Jonathan Gruber, 2006. "A Tax-Based Estimate of the Elasticity of Intertemporal Substitution," NBER Working Papers 11945, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  8. Dybvig, Philip H, 1995. "Dusenberry's Ratcheting of Consumption: Optimal Dynamic Consumption and Investment Given Intolerance for Any Decline in Standard of Living," Review of Economic Studies, Blackwell Publishing, vol. 62(2), pages 287-313, April. [Downloadable!] (restricted)
  9. David Backus & Bryan Routledge & Stanley Zin, 2004. "Exotic Preferences for Macroeconomists," Working Papers 04-20, New York University, Leonard N. Stern School of Business, Department of Economics. [Downloadable!]
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  10. Weil, Philippe, 1990. "Nonexpected Utility in Macroeconomics," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 29-42, February. [Downloadable!] (restricted)
  11. Kingston, Geoffrey, 1989. "Theoretical foundations of constant-proportion portfolio insurance," Economics Letters, Elsevier, vol. 29(4), pages 345-347. [Downloadable!] (restricted)
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  12. Kreps, David M & Porteus, Evan L, 1979. "Dynamic Choice Theory and Dynamic Programming," Econometrica, Econometric Society, vol. 47(1), pages 91-100, January. [Downloadable!] (restricted)
  13. Kreps, David M & Porteus, Evan L, 1978. "Temporal Resolution of Uncertainty and Dynamic Choice Theory," Econometrica, Econometric Society, vol. 46(1), pages 185-200, January. [Downloadable!] (restricted)
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