Two Israeli economists, Haim Levy and Guy Kaplanski, have a new paper, Investment Choices with Envy and Altruism. The go over what kind of utility functions can rationalize the following preferences.
They asked people about the following scenarios:
1.The value of the subject’s investment in stocks increases during the year from $25,000 to $27,500, and the stock index also increased at the same rate.
2. The subject’s investment and the stock index increase exactly as in Scenario 1, while the portfolio of the peer group appreciates by 50%, from $25,000 to $37,500.
3. The subject portfolio as well as the stock index decrease during the year from $25,000 to $22,500.
4. The subject investment and the stock index decrease exactly as in Scenario 3, while the portfolio of the peer group depreciates by 50%, from $25,000 to $12,500.
Needless to say, they find that “envy dominates the results as the utility generally decreases when the peer group earns more and it increases when the peer group loses more than the subject.” It’s relative wealth that matters more than absolute wealth. This is consistent with the theoretical thesis of my book, The Missing Risk Premium (now with 5 reviews, and the ‘Look Inside’ feature is now enabled!).