Keeping Up with the Joneses: An International Asset Pricing Model

Abstract

We derive an international asset pricing model that assumes local investors have preferences of the type "keeping up with the Joneses." In an international setting investors compare their current wealth with that of their peers who live in the same country. In the process of inferring the country's average wealth, investors incorporate information from the domestic market portfolio. In equilibrium, this gives rise to a multifactor CAPM where, together with the world market price of risk, there exists country-speciffic prices of risk associated with deviations from the country's average wealth level. The model performs signifficantly better, in terms of explaining cross-section of returns, than the international CAPM. Moreover, the results are robust, both for conditional and unconditional tests, to the inclusion of currency risk, macroeconomic sources of risk and the Fama and French HML factor.