Specialization in Investor Information and the Diversification Discount

Abstract

We present a theory of the diversification discount based on investor specialization in information; this is modeled by different investors having a lower belief variance for different assets. We show that a discount exists in a general multi-asset, multi-investor setting; the discount increases with the degree of information specialization among investors. We empirically test our model using corporate spinoffs from the USA, using a novel measure of industry similarity based on sell-side analyst behavior. We find that higher abnormal returns on the spinoff announcement date are associated with higher industry dissimilarity between parent and child firms.