This is the question one should ask the theorists of the portfolio diversity
“Do not put all your eggs in one basket” … The formula has been a hit among both laymen and professionals in asset management, the job of the latter being to supply diversified investment portfolios.
Is this one a logical formula?
The answer is no if the goal is to limit the number of occurrences of a disaster. If one invests in only one risky asset, one could well expect 4 times less events of default than when 4 equivalent (and non correlated) risky assets.
The answer is yes if the aim is to reduce the magnitude of the loss should a default happen on one of the 4 assets.
Do granular portfolios translate into purely statistically predictable risk ?
Nobody today can ignore the fate of the U.S. portfolios of sub prime credit. The risk of these portfolios was nevertheless assumed to be tamed thanks to the so many assets in such portfolios !
The better route to follow is hence to…deviate from the usal dogma that transform the risk into a mere figure of probability of default which in some cases can lead to adverse selection and the introduction of ” bad risk assets ” for the sake of mutualizing them with “good risk assets ” .
Plain experience often shows that “more risks ” often leads to “more risk”
Better to remember the primacy of economy over finance and of finance over … maths.
Dominique F. Pasquier