Optimal Discrete Ratchet Consumption
John G. Watson
Financial Engines, Inc.; Stanford University - Graduate School of Business
Jason S. Scott
Financial Engines, Inc.
March 14, 2012
Dybvig  finds optimal spending and investment strategies for a perpetual endowment that has no tolerance for spending declines. His spending rule is a ratchet --- spending never decreases, but has a substantial chance of increasing. We find the ratchet consumption rule for an investor with a finite planning horizon. We maximize an expected utility that eschews pending declines, yet permits a range of choices for felicity and time preference functions. For optimality, a spending rule must be paired with an investment rule. Here, we investigate dynamic investment strategies --- we treat consumption as a derivative security and derive formulas for its delta-hedge.
Number of Pages in PDF File: 40
Keywords: Ratchet, consumption, investment, floor, leverage
JEL Classification: C61, D11, D91, G11, H31, J26working papers series
Date posted: October 29, 2011 ; Last revised: March 15, 2012
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