Preferences on relative return: A potential explanation for some pricing anomalies

Abstract

We derive a version of the CAPM in which investor preferences depend only on the mean and variance of the ratio between the portfolio return and a reference return. The reference return is specific to each investor, and can also be interpreted as a proxy of the consumption of his neighbors. That is, investors in our economy care about how much they consume relative to their neighbors. The model provides a rational potential explanation for the home bias enigma and for other pricing anomalies.

Citation

Lauterbach, B. and Reisman, H. (2002), "Preferences on relative return: A potential explanation for some pricing anomalies", Hirschey, M., John, K. and Makhija, A.K. (Ed.) Innovations in Investments and Corporate Finance (Advances in Financial Economics, Vol. 7), Emerald Group Publishing Limited, Leeds, pp. 93-103. https://doi.org/10.1016/S1569-3732(02)07005-6