Shortfall aversion. (4th March 2020)

• Record Type: Journal Article
• Authors: Guasoni, Paolo; Huberman, Gur; Ren, Dan
• Is Part Of: Mathematical finance. Volume 30:Number 3(2020)
• Page Start: 869
• Page End: 920
• Publication Date: 2020-03-04
• Subjects: consumption -- endowments -- portfolio choice -- shortfall aversion; Business mathematics -- Periodicals; 332
• DOI: 10.1111/mafi.12239
• Languages: English
• ISSNs: 0960-1627

Abstract

Abstract: Shortfall aversion reflects the higher utility loss of spending cuts from a reference than the utility gain from similar spending increases. Inspired by Prospect Theory's loss aversion and the peak‐end rule, this paper posits a model of utility from spending scaled by past peak spending. In contrast to traditional models, which call for spending rates proportional to wealth, the optimal policy in this model implies a constant spending rate equal to the historical peak when wealth is relatively large. The spending rate increases when wealth reaches a model‐determined multiple of peak spending. In 1926–2015, shortfall‐averse spending is smooth and typically increasing.