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If you buy a small piece of many houses you have much less uncertainty because it is incredibly unlikely that they will all fall down. The total loss is the sa

If you buy a small piece of many houses you have much less uncertainty because it is incredibly unlikely that they will all fall down. The total loss is the same but it is spread out so much that it averages out and becomes much more predictable. It reduces volatility (which is often referred to as "risk") but I think you are correctly pointing out that it does not change the average outcome.

gaius 12y ago
Or if you buy a small piece of many mortgages... Oh wait
- vegabook 12y ago
  ha - brilliant. The fallacy of "diversification" is that it only transfers risk intertemporaly. Ultimately someone will get shafted double or more at some stage - it's just a question of arbing the unstable correl matrix while you can... which can and will go to a fully populated matrix of (abs)1s at some unfortunate stage when you (they!) are left holding the baby. You're left hoping that you'll have been paid a few bonuses before that happens....
  - seanflyon 12y ago
    The point of diversification is that no one gets shafted because lots of people are left holding the the "baby" together. It does not reduce the total amount of loss but it trades a 1% chance of losing $50 with a 50% chance of losing $1.
    - vegabook 12y ago
      sure but when correlations go to 1, you're as badly off as if you only had one position. Diversification engenders false senses of security, and moreover, means everybody has a bit of everything. Therefore mass panic can ensue causing the correl matrix to ramp. See: 2008. I contend that diversification makes for great maths, but often poor risk management.
richardwhiuk 12y ago
Assuming that none of your risk is uncorrelated - which is not as true as people wish or hope. E.g. if you buy a huge number of San Francisco you are now very exposed to large earthquakes, or the house price in SF falling due to a tech bubble

gaius 12y ago

Or if you buy a small piece of many mortgages... Oh wait

vegabook 12y ago
ha - brilliant. The fallacy of "diversification" is that it only transfers risk intertemporaly. Ultimately someone will get shafted double or more at some stage - it's just a question of arbing the unstable correl matrix while you can... which can and will go to a fully populated matrix of (abs)1s at some unfortunate stage when you (they!) are left holding the baby. You're left hoping that you'll have been paid a few bonuses before that happens....
- seanflyon 12y ago
  The point of diversification is that no one gets shafted because lots of people are left holding the the "baby" together. It does not reduce the total amount of loss but it trades a 1% chance of losing $50 with a 50% chance of losing $1.
  - vegabook 12y ago
    sure but when correlations go to 1, you're as badly off as if you only had one position. Diversification engenders false senses of security, and moreover, means everybody has a bit of everything. Therefore mass panic can ensue causing the correl matrix to ramp. See: 2008. I contend that diversification makes for great maths, but often poor risk management.

richardwhiuk 12y ago

Assuming that none of your risk is uncorrelated - which is not as true as people wish or hope. E.g. if you buy a huge number of San Francisco you are now very exposed to large earthquakes, or the house price in SF falling due to a tech bubble