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Learning versus Diversification in Project Choice

Author

Listed:
  • Narayanan Subramanian

    (Brandeis University)

  • Nidhiya Menon

    (Brandeis University)

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.

Suggested Citation

  • Narayanan Subramanian & Nidhiya Menon, 2004. "Learning versus Diversification in Project Choice," Game Theory and Information 0403003, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpga:0403003
    Note: Type of Document - pdf; pages: 45. 45 pages, pdf document.
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    File URL: https://econwpa.ub.uni-muenchen.de/econ-wp/game/papers/0403/0403003.pdf
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    More about this item

    Keywords

    Bayesian Learning; Insurance; Risk-Sharing;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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