DP4786 | Portfolio Diversification, Proximity Investment and City Agglomeration

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We study the puzzle of portfolio underdiversification and proximity investment from a novel perspective, linking it to the process of urbanization. We find that urban portfolios are more focused ? i.e., less diversified and more concentrated in ?close? stocks. We explain it in terms of the process of ?professional specialization? that characterizes urban environments. We test this against a number of alternative theories: financial sophistication, social competition and hedging non-financial risk. We show that the very same factors behind the drive to city agglomeration also affect both the degree of portfolio diversification and proximity investing by influencing investor information and risk.