Learning versus Diversification in Project Choice

Narayanan Subramanian and Nidhiya Menon
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Narayanan Subramanian: Brandeis University

Game Theory and Information from University Library of Munich, Germany

Abstract: We 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.

Keywords: Bayesian Learning; Insurance; Risk-Sharing (search for similar items in EconPapers)
JEL-codes: D81 D83 G32 (search for similar items in EconPapers)
Pages: 45 pages
Date: 2004-03-22
New Economics Papers: this item is included in nep-cfn and nep-ent
Note: Type of Document - pdf; pages: 45. 45 pages, pdf document.
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Persistent link: https://EconPapers.repec.org/RePEc:wpa:wuwpga:0403003

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