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Ratchet consumption over finite and infinite planning horizons |
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| Institution: | 1. Financial Engines, Inc., 1050 Enterprise Way, Sunnyvale, CA 94089, USA;2. Stanford Graduate School of Business, 655 Knight Way, Stanford, CA 94305, USA;3. Retiree Research Center, Financial Engines, Inc., 1050 Enterprise Way, Sunnyvale, CA 94089, USA;1. Korea University, Republic of Korea;2. University of Exeter, United Kingdom;1. Center of Economic Research at ETH Zurich (CER-ETH), Switzerland;2. Department of Economics, Maastricht University, Netherlands |
| 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 Lévy process. When the kernel is log-normal, we obtain closed-form solutions for both finite and infinite horizons. |
| Keywords: | Endowment Retirement Ratchet consumption Installment option Expected utility maximization |
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