Abstract
This paper presents findings on three elements relevant to regional economic diversification and stability using concepts from portfolio theory. First, the empirical form of a frontier of efficient portfolios of manufacturing industries is computed and shown in risk/return space. This frontier represents the upper bounds for regional diversification aimed at maximizing expected values for given levels of risk. Second, diversification measures are computed for sample regions and are shown relative to the efficient frontier. Discussion reveals the portfolio approach prescribes superior normative guides relative to other approaches to diversification. Third, statistical tests are undertaken to determine if a portfolio diversification measure can explain cross-sectional differences in subsequently realized instability.
Highlights
This paper presents findings on three elements relevant to regional economic diversification and stability using concepts from portfolio theory
He noted that the proportion of variation in regional economic instability (REI) explained by other diversification measures was less than one-eighth of that explained by the portfolio variance measure
This paper presents analysis of Standard Metropolitan Statistical Areas (SMSAs) diversification and instability
Summary
Interest in causes and cures of economic instability is generally heightened when extended periods of economic stagnation and decline are experienced, such as the recent situation in many countries. Conroy made a very important contribution by suggesting a portfolio theory approach to industrial diversification He incorporated Siegel's (1966) measure of regional economic instability (REI) in crosssectional models where portfolio variance and other measures of industrial diversification were used as independent variables. Kort used a variance measure of REI similar to that of Conroy and alternative measures of industrial diversification in crosssectional regressions His results indicated that, after using population size to correct for observed heteroscedasticity, an entropy measure of industrial diversification could explain 64.2% of the variation in REI across the sample regions. The work of Conroy and Kort indicates an ex post tie between observed REI and the industrial diversification of a region, with portfolio variance being the preferred measure of diversification.
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