Scenario analysis with recursive utility: Dynamic consumption plans for charitable endowments

Vol: 
03/2008
Author name: 
Satchell S
Thorp S
Year: 
2008
Month: 
January
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 investmentrisk 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.

Publication file: 

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