|
This study contributes to the growing literature on the link between portfolio diversification
and its implications on the question of systemic risk. We first show that the introduction of
any contingent claim, whose value is correlated with the value of the assets owned by a
population of heterogeneous agents, causes an improvement of the agents’ expected utility.
At the same time, such an introduction will increase the overall systemic risk. These effects
are due to the cumulative interaction of two distinct but closely related factors:
- The gain obtained from diversifying one’s portfolio, thus reducing risk exposure
through risk sharing; and
- The gain obtained through risk shifting from higher to lower risk-aversion agents.
We test the hypothesis on the negative relationship between diversification and systemic
risk by estimating a simultaneous equation model for a panel of 266 largest mutual funds1 (based on size). In particular, we use 162 funds to analyze the US market and 64 funds for the
European area, exchanged in the market between January 2003 and March 2010.
The paper first reviews the basic concepts and some of the recent literature on systemic
risk, in particular, the relationship between diversification and systemic risk. It then develops
a theoretical model that captures the essence of this relationship by analyzing the effects on
both diversification and systemic risks of the issuance of an additional security. Later, the
paper describes the dataset, presents the econometric analysis and the results obtained, before
closing with discussion and some conclusive remarks.
|
