FOMO Economics: External Reference-Dependence in Household Portfolios
Abstract
Individual investors are sensitive to peer performance and particularly dislike “falling behind.” We use unique granular data on the transactions and holdings of retail investors to study portfolio adjustment in response to relative performance of their portfolios. We show that investor behavior is consistent with preferences over future wealth that are S-shaped around an external reference point provided by a salient market benchmark: if their portfolio lags the “market,” they tend to increase the risky share of their portfolio, as well as purchase riskier securities, as characterized by high market beta, idiosyncratic volatility, and positive skewness. As the salience of the market index increases, investors become more sensitive to relative performance. The effect is asymmetric, more pronounced in bull market periods, and does not reverse when individual portfolios are ahead of the market. Our evidence provides a novel perspective on the individual investors’ demand for risky assets.