Learning versus Diversification in Project Choice
AbstractWe study the issue of project choice when a risk-averse agent must choose whether to invest in two projects of the same type (focus) or of different types (diversification). Projects of the same type are subject to common type-specific shocks. Hence focusing is more risky within each period, but enables faster learning across periods. Optimal project choice involves balancing these two considerations. We demonstrate how an agent's choice of whether to focus or diversify is related to (i) the speed of learning (ii) the type-specific risk and (iii) his risk- aversion and investment horizon. We show that, contrary to intuition, an increase in type-specific risk may lead to a decrease in diversification. Our theory is applicable to occupational choice within households, project choice under group lending, and corporate diversification.
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Bibliographic InfoPaper provided by EconWPA in its series Game Theory and Information with number 0403003.
Length: 45 pages
Date of creation: 22 Mar 2004
Date of revision:
Note: Type of Document - pdf; pages: 45. 45 pages, pdf document.
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Bayesian Learning; Insurance; Risk-Sharing;
Find related papers by JEL classification:
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search, Learning, and Information
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
This paper has been announced in the following NEP Reports:
- NEP-ALL-2004-03-28 (All new papers)
- NEP-CFN-2004-03-28 (Corporate Finance)
- NEP-ENT-2004-03-28 (Entrepreneurship)
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