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Investment and Concern for Relative Position

  • Harold L. Cole
  • George J. Mailath
  • Andrew Postlewaite

Economists typically analyze individuals' market behavior in isolation from their nonmarket decisions. While this research strategy has generally been successful, it can lead to systematic errors when agents' nonmarket behavior affects their market choices. In this paper we analyze how individuals' investment behavior changes as a result of nonmarket behavior. Specifically, we analyze a model in which individuals must decide how to allocate their initial endowment between two random investments, where the returns are perfectly correlated across individuals for the first investment but independent across individuals for the second. We consider an environment in which men and women match, with wealthier individuals more successful in matching. We show how individuals' concern about relative wealth can affect their investment decisions, and we provide conditions under which individuals bias their investments either toward or away from the investment with correlated returns. A modification of the model is used to explain why agents investments might exhibit a home country bias.

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Paper provided by Penn Economics Department in its series Penn CARESS Working Papers with number adb2940730338ff113d930aa2e42ccdf.

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Handle: RePEc:cla:penntw:adb2940730338ff113d930aa2e42ccdf
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