Investment decisions with loss aversion over relative consumption

We study an exchange economy in which investors are loss averse over relative consumption, that is, they suffer a utility loss if they consume less than members of their reference group. As a consequence there is an incentive to hold the same portfolio of risky assets as the reference group. Thus, risk premia can be supported in equilibrium that diverge from the risk premia obtained without loss aversion over relative consumption. This effect may be used to explain time-varying risk premia that are empirically observed for many assets.

► Exchange Economy with investors that are loss averse over relative consumption. ► Investors have an incentive to hold the same portfolio of risky assets as their reference group. ► Risk premia can diverge from the risk premia obtained without loss aversion over relative consumption.