The Origin of Diversification: An Evolutionary Theory
34 Pages Posted: 21 Jul 2017
Date Written: July 18, 2017
Diversification is a fundamental concept in economics, decision theory and finance. It also lies at the core of the Darwinian evolution argument, and diversifying behavior known as bet-hedging has been widely documented in other species. The central premise of this paper is that attitudes towards diversification are, at least in part, the evolutionary product of natural selection. The main contribution consists of an evolutionary choice model relating diversifying behavior to evolutionary fitness, which is used to prove that diversification is advantageous from an evolutionary perspective. Two situations are distinguished: in the model under risk, when probabilities of future reproductive success are known, natural selection favours the traditional mean-variance diversification strategy, whereas in the model under uncertainty, when probabilities are unknown, the naive diversification heuristic and the related principle of insufficient reason emerge as maximizing evolutionary fitness. These insights into the potentially biological origins of diversifying behavior may have implications for how one can treat observed anomalies in practice.
Keywords: diversification, naive diversification, evolutionary choice, fitness, natural selection, portfolio choice
JEL Classification: B52, D01, D80, D90, D91, G11, G41
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