Sunday, June 25, 2006

Appropriate levels of diversification for lenders

I frequently hear people discussing the inadequate diversification of various lenders' Prosper portfolios.

Here's the thing -- other than for tax/mental bucketing/liquidity reasons, who the heck should care if your Prosper portfolio is inadequately diversified?

Leaving aside the issue of what "inadequate" diversification means, rational investors should only care about their total portfolio profiles. Insofar as my Prosper portfolio is horribly unbalanced, but its risk/return/correlation profile makes my entire portfolio higher return, lower risk, and less correlated with bad states of the world, say, I'm still better off. A separate question would be whether an even better total portfolio outcome would be possible with a different Prosper allocation strategy.

I could see Prosper trying to keep lenders diversified so people don't start causing mega negative publicity when their Prosper only portfolio goes underwater due to one default, but other than that...

[Inspired by an exception to pninen's typically well thought out (though equally frequently overly harsh :) ) set of posts...]


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