Risk, Ambiguity, and the Value of Diversification

Risk, Ambiguity, and the Value of Diversification

Berger L., Eeckhoudt L., (2021), Risk, Ambiguity, and the Value of Diversification, Management Science, DOI: 10.1287/mnsc.2020.3823, webpage

Abstract

Diversification is a basic economic principle that helps to hedge against uncertainty. It is, therefore, intuitive that both risk aversion and ambiguity aversion should positively affect the value of diversification. In this paper, we show that this intuition (1) is true for risk aversion but (2) is not necessarily true for ambiguity aversion. We derive sufficient conditions, showing that, contrary to the economic intuition, ambiguity and ambiguity aversion may actually reduce the diversification value.

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