On a Stochastic Model of Diversification

Abstract

We propose a definition of diversification as a binary relationship between financial portfolios. According to it, a convex linear combination of several risk positions with some weights is considered to be less risky than the probabilistic mixture of the same risk positions with the same weights. It turns out to be that the proposed partial ordering coincides with the well-known second order stochastic dominance, but allows to take a look at it from another perspective.