Financial diversification is a mathematical illusion if all institutions use the same risk-assessment models.
April 1, 2026
Original Paper
Covariance Singularity in Financial Decision Systems: How Shared Inferential Infrastructure Undermines Diversification
SSRN · 6309258
The Takeaway
We assume that spreading risk across many independent banks makes the financial system safe. This paper reveals that because most institutions now use identical 'inferential infrastructure' (the same data and algorithms), the entire global system behaves like a single point of failure regardless of how many banks there are.
From the abstract
We show that under identifiable conditions, the effective number of independent risk assessments in a financial system can collapse to a small constant, regardless of the number of institutions. We call this the Analytical Diversification Limit: for sufficiently high methodological alignment, no amount of institutional proliferation restores analytical independence. In the large-system limit, the effective number of independent risk assessments converges to 1/β⁴, where β measures alignment with