Keeping up with the Joneses and optimal diversification

Peer-effects have been shown to affect behavior, and can generally lead to investments choices that are mean-variance inefficient. This paper analyzes optimal diversification with peer-effects. We show that if individuals have keeping-up with the Joneses preferences and they take their peer-group reference as the market portfolio, Markowitz's mean-variance efficiency analysis and the CAPM equilibrium are intact. This holds for any keeping-up preferences, as well as heterogeneous combinations of such preferences. These results also extend to the Merton-Levy segmented-market model.