Optimal Continuous Ratchet Consumption

17 Pages Posted: 20 Dec 2013 Last revised: 10 Jun 2014

See all articles by John G. Watson

John G. Watson

Financial Engines, Inc.; Stanford Graduate School of Business

Jason S. Scott

Financial Engines, Inc.

Date Written: June 9, 2014

Abstract

Ratchet consumers want their spending to always increase and never decrease. We find an optimal consumption rule for ratchet consumers by maximizing an expected utility that eschews spending declines, yet permits a range of choices for felicity and time preference functions. This solution can be tailored to fit both retirees with finite planning horizons and endowments with infinite planning horizons. We assume complete markets modeled by a pricing kernel generated by a Levy processes. When the kernel is log-normal, we obtain closed-form solutions for both finite and infinite horizons.

Keywords: Ratchet, consumption, retirees, endowments

JEL Classification: D91

Suggested Citation

Watson, John G. and Scott, Jason S., Optimal Continuous Ratchet Consumption (June 9, 2014). Available at SSRN: https://ssrn.com/abstract=2369552 or http://dx.doi.org/10.2139/ssrn.2369552

John G. Watson (Contact Author)

Financial Engines, Inc. ( email )

1050 Enterprise Way
Sunnyvale, CA 94089
United States

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305
United States

Jason S. Scott

Financial Engines, Inc. ( email )

1050 Enterprise Way, 3rd Floor
Sunnyvale, CA 94089
United States

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