The effect of relative wealth concerns on the cross-section of stock returns

There are several economic reasons why investors might want to hedge local risk resulting from relative wealth concerns; namely, keeping up with the Joneses preferences and competition for local assets in short supply. In equilibrium, hedging for these purposes results in a negative risk Premium for the local risk factors. We study the empirical implications of this equilibrium at the level of the nine US census divisions. As a proxy for the local risk factor we use regional labor income growth. In explaining the cross-section of stock returns, the model performs substantially better than the CAPM, and as well as the Fama-French three factor model.