Econometrica: Jan 1989, Volume 57, Issue 1
Asset Demand Without the Independence Axiom
Eddie DekelAn important application of the theory of choice under uncertainty is to asset markets and an important property in these markets is a preference for portfolio diversification. If an investor is an expected utility maximizer, then (s)he is risk averse if and only if (s)he exhibits a preference for diversification. This paper examines the relationship between risk aversion and protfolio diversification when preferences over probability distributions of wealth do not have an expected utility representation. Although risk aversion is not sufficient to guarantee a preference for portfolio diversification, it is necessary. Quasicon-cavity of the preference functional (over probability distributions of wealth) together with risk aversion does imply a preference for portfolio diversification.
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