Dusenberry's Ratcheting of Consumption: Optimal Dynamic Consumption and Investment Given Intolerance for any Decline in Standard of Living

Abstract

Duesenberry's ratcheting consumption demand is derived as a feature of the optimal dynamic consumption and investment policy given extreme habit formation that prevents consumption from falling over time. Preferences are in effect non-time-separable extended-real-valued von Neumann-Morgenstern preferences. Consumption increases each time wealth reaches a new maximum. Risky investment is proportional to the excess of wealth over the perpetuity value of current consumption. Extensions constrain the net rate of decrease in consumption with a constant other than zero, add more consumption goods, and constrain on the maximal holding of the risky asset as a proportion of wealth. These strategies may be useful for the management of university endowments, participatory investment accounts, and risky arbitrage funds.