Diversification Preferences in the Theory of Choice
Decisions in Economics and Finance, Forthcoming
35 Pages Posted: 8 Jul 2015 Last revised: 5 Nov 2016
Date Written: October 6, 2016
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: Suggested Citation