Optimal Continuous Ratchet Consumption

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