The Willingness to Pay for Diversification

29 Pages Posted: 27 Oct 2018

See all articles by Ola Mahmoud

Ola Mahmoud

University of California, Berkeley; University of Zurich

Date Written: October 4, 2018

Abstract

Diversification is a fundamental concept in economics, finance, and decision theory. This paper argues that decision makers assign an intrinsic value to the notion of diversification and that this “willingness to pay” is driven by risk aversion and loss aversion. In an experimental study replicating a portfolio choice problem using simple gambles, the value of diversification is elicited and estimated to be at 5% of the initial endowment. The experiment further shows that risk averse and loss averse individuals are willing to pay more for diversification. The paper’s findings point to the idea that diversification is an intrinsic behavioral heuristic and may help explain some portfolio choice anomalies in practice, such as irrational diversification, the diversification bias, and overdiversification.

Keywords: Diversification, Portfolio Choice, Diversification Cost, Irrational Diversification, Diversification Bias, Risk Aversion, Loss Aversion

JEL Classification: C91, D01, D90, G11, G40

Suggested Citation

Mahmoud, Ola, The Willingness to Pay for Diversification (October 4, 2018). Available at SSRN: https://ssrn.com/abstract=3260609 or http://dx.doi.org/10.2139/ssrn.3260609

Ola Mahmoud (Contact Author)

University of California, Berkeley ( email )

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

University of Zurich ( email )

Schönberggasse 1
Zürich, 8001
Switzerland

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