Scenario Analysis with Recursive Utility: Dynamic Consumption Plans for Charitable Endowments

51 Pages Posted: 3 Mar 2008

See all articles by Stephen E. Satchell

Stephen E. Satchell

University of Cambridge - Faculty of Economics and Politics

Susan Thorp

University of Sydney Business School; Financial Research Network (FIRN); Centre for International Finance and Regulation (CIFR)

Date Written: December 20, 2007

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.

Keywords: Recursive utility, Stochastic dominance, Inter-temporal choice

JEL Classification: G00, D81, D91

Suggested Citation

Satchell, Stephen E. and Thorp, Susan, Scenario Analysis with Recursive Utility: Dynamic Consumption Plans for Charitable Endowments (December 20, 2007). ; EFA 2008 Athens Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1096427 or http://dx.doi.org/10.2139/ssrn.1096427

Stephen E. Satchell

University of Cambridge - Faculty of Economics and Politics ( email )

Austin Robinson Building
Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom
44 (0)1223 335213 (Phone)
44 (0)1223 335475 (Fax)

HOME PAGE: http://www.econ.cam.ac.uk/faculty/satchell/index.h

Susan Thorp (Contact Author)

University of Sydney Business School ( email )

P.O. Box H58
Sydney, NSW 2006
Australia
+61 2 9351 6354 (Phone)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Centre for International Finance and Regulation (CIFR) ( email )

Level 7, UNSW CBD Campus
1 O'Connell Street
Sydney, NSW 2000
Australia

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