Risk, Ambiguity, and the Value of Diversification
Management Science · 2021 · Volume 67 · Issue 3
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. This paper was accepted by Manel Baucells, decision analysis.
Keywords
diversification, ambiguity aversion, model uncertainty, hedging
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