Sectoral Allocation, Risk Efficiency and the Great Moderation

This paper argues that the decline in U.S. real GDP growth volatility after the mid 1980s was an outcome of more risk efficient and more diversified sectoral allocations. Using a portfolio approach, I distinguish between the two determinants of GDP growth volatility: sectoral covariances and sectoral allocations. I use the sectoral growth and covariances to com- pute the growth-volatility frontier of the economy. I define the efficiency of the actual sectoral allocation as the distance of t...