Abstract:

Incorporating preference for social status into a simple model of portfolio choice helps to explain a range of qualitative and quantitative stylized facts about the heterogeneity in asset holdings among U.S. households. I specify preferences for status parsimoniously as a function of a households wealth relative to the per capita wealth level. In the model, investors hold undiversified portfolios in equilibrium because of the greater aversion to aggregate risk that stems from the relative wealth concerns. This prediction provides a possible explanation for the apparently small premium for undiversified entrepreneurial risk. Consistently with empirical evidence, the wealthier households own a disproportionate share of risky assets, particularly private equity, and experience more volatile consumption growth. The calibrated model can match the empirical level of risky asset holdings and the degree of wealth mobility among the rich without generating excessive volatility of aggregate consumption growth.