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

45 Pages Posted: 7 Jun 2008 Last revised: 13 Dec 2011

Nikolai L. Roussanov

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Date Written: May 11, 2010

Abstract

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

Keywords: portfolio choice, diversification, social status, wealth distribution

JEL Classification: E21, G11, D14, D31, L26

Suggested Citation

Roussanov, Nikolai L., Diversification and its Discontents: Idiosyncratic and Entrepreneurial Risk in the Quest for Social Status (May 11, 2010). Journal of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1142122

Nikolai L. Roussanov (Contact Author)

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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