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

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  • Stephen Satchell

    ()

  • Susan Thorp

    ()

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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Bibliographic Info

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

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

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  1. Kingston, Geoffrey, 1989. "Theoretical foundations of constant-proportion portfolio insurance," Economics Letters, Elsevier, Elsevier, vol. 29(4), pages 345-347.
  2. Kreps, David M & Porteus, Evan L, 1979. "Dynamic Choice Theory and Dynamic Programming," Econometrica, Econometric Society, Econometric Society, vol. 47(1), pages 91-100, January.
  3. Stephen G. Dimmock, 2012. "Background Risk and University Endowment Funds," The Review of Economics and Statistics, MIT Press, vol. 94(3), pages 789-799, August.
  4. Smith, William T., 1996. "Feasibility and transversality conditions for models of portfolio choice with non-expected utility in continuous time," Economics Letters, Elsevier, Elsevier, vol. 53(2), pages 123-131, November.
  5. Nichols, Donald A, 1974. "The Investment Income Formula of the American Economic Association," American Economic Review, American Economic Association, American Economic Association, vol. 64(2), pages 420-26, May.
  6. R. C. Merton, 1970. "Optimum Consumption and Portfolio Rules in a Continuous-time Model," Working papers, Massachusetts Institute of Technology (MIT), Department of Economics 58, Massachusetts Institute of Technology (MIT), Department of Economics.
  7. Bhamra, Harjoat S. & Uppal, Raman, 2005. "The Role of Risk Aversion and Intertemporal Substitution in Dynamic Consumption-Portfolio Choicewith Recursive Utility," CEPR Discussion Papers, C.E.P.R. Discussion Papers 5020, C.E.P.R. Discussion Papers.
  8. Weil, Philippe, 1990. "Nonexpected Utility in Macroeconomics," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 105(1), pages 29-42, February.
  9. David M Kreps & Evan L Porteus, 1978. "Temporal Resolution of Uncertainty and Dynamic Choice Theory," Levine's Working Paper Archive 625018000000000009, David K. Levine.
  10. Josh Lerner & Antoinette Schoar & Wan Wong, 2005. "Smart Institutions, Foolish Choices? The Limited Partner Performance Puzzle," NBER Working Papers 11136, National Bureau of Economic Research, Inc.
  11. Alberto Giovannini & Philippe Jorion, 1989. "Time-Series Tests of a Non-Expected-Utility Model of Asset Pricing," NBER Working Papers 3195, National Bureau of Economic Research, Inc.
  12. 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, Wiley Blackwell, Wiley Blackwell, vol. 62(2), pages 287-313, April.
  13. Merton, Robert C, 1969. "Lifetime Portfolio Selection under Uncertainty: The Continuous-Time Case," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 247-57, August.
  14. Jonathan Gruber, 2006. "A Tax-Based Estimate of the Elasticity of Intertemporal Substitution," NBER Working Papers 11945, National Bureau of Economic Research, Inc.
  15. David Backus & Bryan Routledge & Stanley Zin, 2004. "Exotic Preferences for Macroeconomists," Working Papers, New York University, Leonard N. Stern School of Business, Department of Economics 04-20, New York University, Leonard N. Stern School of Business, Department of Economics.
  16. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 99(2), pages 263-86, April.
  17. Tobin, James, 1974. "What Is Permanent Endowment Income?," American Economic Review, American Economic Association, American Economic Association, vol. 64(2), pages 427-32, May.
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Cited by:
  1. Stephen Satchell & Susan Thorp, 2011. "Uncertain survival and time discounting: intertemporal consumption plans for family trusts," Journal of Population Economics, Springer, Springer, vol. 24(1), pages 239-266, January.

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