MISERY LOVES COMPANY: EQUILIBRIUM PORTFOLIOS WITH HETEROGENEOUS CONSUMPTION EXTERNALITIES

Christian Gollier ()

International Economic Review, 2004, vol. 45, issue 4, 1169-1192

Abstract: The present article extends the Arrow-Debreu portfolio model to consumption externalities. It is assumed that each investor has a von Neumann-Morgenstern utility that is a function of her own consumption and of the average consumption in the group to which she belongs. Individual degrees of risk aversion and conformism are heterogeneous within each group and between the different groups in the economy. We show that, under some conditions on the degree of conformism in the economy, the optimal portfolio and consumption choices observed at equilibrium in each group with consumption externalities are equivalent to those that are optimal without any externality, but with an adjusted degree of risk aversion. If these conditions are not fulfilled, groups have no representative agent and the demand for pure zero-mean lotteries may be positive, thereby showing that not all diversifiable risks are washed away at equilibrium. We characterize the relationship between the distribution of conformism in the economy to the competitive allocation of risk and to the equity premium. We provide conditions for the two-fund separation property to hold. Copyright 2004 by the Economics Department Of The University Of Pennsylvania And Osaka University Institute Of Social And Economic Research Association.

Date: 2004
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