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On the Microeconomics of Diversification under Uncertainty and Learning

  • Chavas, Jean-Paul

    (U of Wisconsin)

  • Barham, Bradford

This paper investigates the microeconomics of diversification, based on a two-period model of an owner-managed firm facing uncertainty. The analysis utilizes a general state-contingent representation of uncertainty and learning. Economies of diversification are defined based on a certainty equivalent, which has three components: expected profit, the risk premium (measuring the cost of risk aversion), and the value of information associated with learning. The influence of scale effects, "trans-ray concavity" effects, and income effects on economies of diversification are examined in detail. We argue that, while scope economies and risk aversion can provide general incentives for diversification, information and learning can have the opposite effect. By integrating scope, risk, and the role of information, our analysis provides new insights on existing economic tradeoffs between firm diversification and specialization.

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File URL: http://www.aae.wisc.edu/pubs/sps/pdf/stpap515.pdf
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Paper provided by University of Wisconsin, Agricultural and Applied Economics in its series Staff Paper Series with number 515.

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Date of creation: Oct 2007
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Handle: RePEc:ecl:wisagr:515
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  1. Banerjee, Abhijit V & Newman, Andrew F, 1994. "Poverty, Incentives, and Development," American Economic Review, American Economic Association, vol. 84(2), pages 211-15, May.
  2. Allen N. Berger & Gerald A. Hanweck & David B. Humphrey, 1986. "Competitive viability in banking: scale, scope, and product mix economies," Research Papers in Banking and Financial Economics 82, Board of Governors of the Federal Reserve System (U.S.).
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  4. Laurent E. Calvet & John Y. Campbell & Paolo Sodini, 2006. "Down or Out: Assessing the Welfare Costs of Household Investment Mistakes," Harvard Institute of Economic Research Working Papers 2107, Harvard - Institute of Economic Research.
  5. Chavas, Jean-Paul, 2001. "Structural change in agricultural production: Economics, technology and policy," Handbook of Agricultural Economics, in: B. L. Gardner & G. C. Rausser (ed.), Handbook of Agricultural Economics, edition 1, volume 1, chapter 5, pages 263-285 Elsevier.
  6. repec:cup:cbooks:9780521622448 is not listed on IDEAS
  7. Barrett, Christopher B. & Bezuneh, Mesfin & Clay, Daniel C. & Reardon, Thomas, 2001. "Heterogeneous Contraints, Incentives, and Income Diversification Strategies in Rural Africa," Working Papers 179567, Cornell University, Department of Applied Economics and Management.
  8. Xavier Gabaix & David Laibson & Guillermo Moloche & Stephen Weinberg, 2006. "Costly Information Acquisition: Experimental Analysis of a Boundedly Rational Model," American Economic Review, American Economic Association, vol. 96(4), pages 1043-1068, September.
  9. Chavas, Jean-Paul & Aliber, Michael, 1993. "An Analysis Of Economic Efficiency In Agriculture: A Nonparametric Approach," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 18(01), July.
  10. Quiggin, John, 1982. "A theory of anticipated utility," Journal of Economic Behavior & Organization, Elsevier, vol. 3(4), pages 323-343, December.
  11. Antonelli, Cristiano, 1993. "Externalities and complementarities in telecommunications dynamics," International Journal of Industrial Organization, Elsevier, vol. 11(3), pages 437-447, September.
  12. Zeckhauser, Richard, 2007. "Investing in the Unknown and Unknowable," Working Paper Series rwp07-005, Harvard University, John F. Kennedy School of Government.
  13. Magill, Michael & Shafer, Wayne, 1991. "Incomplete markets," Handbook of Mathematical Economics, in: W. Hildenbrand & H. Sonnenschein (ed.), Handbook of Mathematical Economics, edition 1, volume 4, chapter 30, pages 1523-1614 Elsevier.
  14. Günter Lang & Peter Welzel, 1998. "Technology and Cost Efficiency in Universal Banking A “Thick Frontier”-Analysis of the German Banking Industry," Journal of Productivity Analysis, Springer, vol. 10(1), pages 63-84, July.
  15. Anbarci, Nejat & Lemke, Robert & Roy, Santanu, 2002. "Inter-firm complementarities in R&D: a re-examination of the relative performance of joint ventures," International Journal of Industrial Organization, Elsevier, vol. 20(2), pages 191-213, February.
  16. Eswaran, Mukesh & Kotwal, Ashok, 1990. "Implications of Credit Constraints for Risk Behaviour in Less Developed Economies," Oxford Economic Papers, Oxford University Press, vol. 42(2), pages 473-82, April.
  17. Kelly, Morgan, 1995. "All their eggs in one basket: Portfolio diversification of US households," Journal of Economic Behavior & Organization, Elsevier, vol. 27(1), pages 87-96, June.
  18. Machina, Mark J, 1982. ""Expected Utility" Analysis without the Independence Axiom," Econometrica, Econometric Society, vol. 50(2), pages 277-323, March.
  19. Tor Jakob Klette, 1996. "R&D, Scope Economies, and Plant Performance," RAND Journal of Economics, The RAND Corporation, vol. 27(3), pages 502-522, Autumn.
  20. William N. Goetzmann & Alok Kumar, 2005. "Why Do Individual Investors Hold Under-Diversified Portfolios?," Yale School of Management Working Papers ysm454, Yale School of Management.
  21. William M. Gentry & R. Glenn Hubbard, 2000. "Entrepreneurship and Household Saving," NBER Working Papers 7894, National Bureau of Economic Research, Inc.
  22. repec:cup:cbooks:9780521785235 is not listed on IDEAS
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