Flight-to-concentration: A preference-based diagnostic for stress regimes

Portfolio theory predicts diversification , yet observed portfolios often become more concentrated in stress. Our study asks when Rank-Dependent Utility (RDU) can overturn the Expected Utility benchmark in a stylized binary stress test. The diversification-versus-concentration comparison reduces to a three-point diagnostic, H(p,q), involving the weighting function at the marginal loss probability p, the joint-loss probability q, and the probability of at least one loss 2p−q. Geometrically, concentration arises when the weighting function is sufficiently convex on the stress band [q,2p−q], penalizing the intermediate partial loss state. As q→p, the diversified and concentrated positions coincide and the preference gap vanishes, so dependence does not mechanically strengthen concentration incentives. A crisis window illustration shows that plausible stress beliefs can move the diagnostic across zero under sufficiently strong probability weighting.