%0 Generic %A Tasca, Paolo %A Battiston, Stefano %C London, UK %D 2014 %F discovery:10186749 %I Systemic Risk Centre, London School of Economics and Political Science %K Naive Diversification, Leverage, Default Probability %N 10 %T Diversification and Financial Stability %U https://discovery.ucl.ac.uk/id/eprint/10186749/ %X The recent credit crisis of 2007/08 has raised a debate about the so-called knife-edge properties of financial markets. The paper contributes to the debate shedding light on the controversial relation between risk-diversification and financial stability. We model a financial network where assets held by borrowers to meet their obligations, include claims against other borrowers and securities exogenous to the network. The balance-sheet approach is conjugated with a stochastic setting and by a mean-field approximation the law of motion of the system's fragility is derived. We show that diversification has an ambiguous effect and beyond a certain levels elicits financial instability. Moreover, we find that risk-sharing restrictions create a socially preferable outcome. Our findings have significant implications for future policy recommendation. %Z This version is the version of record. For information on re-use, please refer to the publisher’s terms and conditions.