Diversification and Its Discontents: Idiosyncratic and Entrepreneurial Risk in the Quest for Social Status

Social status concerns influence investors' decisions by driving a wedge in attitudes toward aggregate and idiosyncratic risks. I model such concerns by emphasizing the desire to "get ahead of the Joneses," which implies that aversion to idiosyncratic risk is lower than aversion to aggregate risk. The model predicts that investors hold concentrated portfolios in equilibrium, which helps rationalize the small premium for undiversified entrepreneurial risk. In the model, status concerns are more important for wealthier households. Consequently, these households own a disproportionate share of risky assets, particularly private equity, and experience greater volatility of consumption, consistent with empirical evidence. Copyright (c) 2010 the American Finance Association.