How dark is the dark side of diversification?

Pedro Cadenas; Henryk Gzyl; Hyun Woong Park

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arXiv · 2012.12154

How dark is the dark side of diversification?

Pedro Cadenas·Henryk Gzyl·Hyun Woong Park

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Abstract

Against the widely held belief that diversification at banking institutions contributes to the stability of the financial system, Wagner (2010) found that diversification actually makes systemic crisis more likely. While it is true, as Wagner asserts, that the probability of joint default of the diversified portfolios is larger; we contend that, as common practice, the effect of diversification is examined with respect to a risk measure like VaR. We find that when banks use VaR, diversification does reduce individual and systemic risk. This, in turn, generates a different set of incentives for banks and regulators.

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Pedro Cadenas, Henryk Gzyl, Hyun Woong Park. 2020-12-22. How dark is the dark side of diversification?. https://arxiv.org/abs/2012.12154

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