378
MACROECONOMICS
D
IVERSIFICATION
refers to the ability of an agent to reduce risk by holding a
number of financial securities in a portfolio. As the returns on different invest-
ments are not perfectly correlated, an institution can diversify away significant
portfolio risk by exploiting the benefits of size. When a portfolio is allocated to
a large number of stocks and bonds, then even if some financial asset experi-
ences a decline in value, there is a good chance that other assets will rise in
value with the gains offsetting the losses.
R
ISK
POOLING
occurs because financial intermediaries that extend credit
using funds raised ...
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