Relative Wealth Concerns and Complementarities in Information Acquisition
50 Pages Posted: 25 Mar 2008 Last revised: 26 Oct 2008
Date Written: October 7, 2008
Abstract
Economists have long believed that relative consumption effects, in which a person's satisfaction with their own consumption depends on how much others are consuming, are important. This paper studies how relative wealth concerns affect investors' incentives to acquire information. We find that such consumption externalities can generate complementarities in information acquisition within the standard rational expectations paradigm. Rather intuitively, when agents care about each other's wealth, multiple equilibria can arise, in which agents mimic each other's information acquisition decisions. We further show how this multiplicity of equilibria can endogenously generate jumps in asset prices: an infinitesimal shift in fundamentals can lead to a discrete price movement. Crashes in our model are accompanied by an increase in the equity premium and a reduction in price informativeness.
Keywords: Keeping up with the Joneses, Consumption externalities, Complementarities in information acquisition, Jumps in asset prices
JEL Classification: D82, G14
Suggested Citation: Suggested Citation