Scenario Analysis with Recursive Utility: Dynamic Consumption Plans for Charitable Endowments
51 Pages Posted: 3 Mar 2008
Date Written: December 20, 2007
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
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