Abstract
Diversification is generally regarded as an efficient tool to reduce portfolio risks. In “An unexpected stochastic dominance: Pareto distributions, dependence, and diversification,” Chen, Embrechts, and Wang showed that the weighted average of independent and identically distributed (i.i.d.) Pareto random variables with infinite mean is larger than one such random variable in the sense of first-order stochastic dominance, and thus diversification is, surprisingly, worse than no diversification. The relation implies superadditivity of value-at-risk, a regulatory risk measure used in the finance and insurance sectors. The obtained relation also holds under some form of negative dependence.
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