Diversification Preferences in the Theory of Choice

Decisions in Economics and Finance, Forthcoming

35 Pages Posted: 8 Jul 2015 Last revised: 5 Nov 2016

Enrico G. De Giorgi

University of St. Gallen - SEPS: Economics and Political Sciences

Ola Mahmoud

University of St. Gallen; University of California, Berkeley

Date Written: October 6, 2016

Abstract

Diversification represents the idea of choosing variety over uniformity. Within the theory of choice, desirability of diversification is axiomatized as preference for a convex combination of choices that are equivalently ranked. This corresponds to the notion of risk aversion when one assumes the von-Neumann-Morgenstern expected utility model, but the equivalence fails to hold in other models. This paper analyzes axiomatizations of the concept of diversification and their relationship to the related notions of risk aversion and convex preferences within different choice theoretic models. The article covers model-independent diversification preferences, preferences within models of choice under risk, including expected utility theory and the more general rank-dependent expected utility theory, as well as models of choice under uncertainty axiomatized via Choquet expected utility theory. Remarks on interpretations of diversification preferences within models of behavioral choice are given in the conclusion.

Keywords: diversification, risk aversion, convex preferences

JEL Classification: D81, G11

Suggested Citation

De Giorgi, Enrico G. and Mahmoud, Ola, Diversification Preferences in the Theory of Choice (October 6, 2016). Decisions in Economics and Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2627970 or http://dx.doi.org/10.2139/ssrn.2627970

Enrico G. De Giorgi

University of St. Gallen - SEPS: Economics and Political Sciences ( email )

Institute of Mathematics and Statistics
Bodanstrasse 6
CH-9000 St. Gallen
Switzerland
+41712242430 (Phone)

Ola Mahmoud (Contact Author)

University of St. Gallen ( email )

Faculty of Mathematics and Statistics
Bodanstrasse 6
Saint Gallen, St. Gallen CH-9000
Switzerland

University of California, Berkeley ( email )

Center for Risk Management Research
Evans Hall
Berkeley, CA 94720
United States

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