A Reappraisal of the Allocation Puzzle through thePortfolio Approach

Paradoxically, high-investment and high-growth developing countries tend toexperience capital outows. This paper shows that this allocation puzzle can beexplained simply by introducing uninsurable idiosyncratic investment risk in theneoclassical growth model. Using a sample of 67 countries between 1980 and 2003,we show that the model predicts accurately the allocation of capital ows in thissample. This is because the model accounts for two main facts: (i) TFP growth ispositively correlated with capital outows in a sample including creditor countries;(ii) the long-run level of capital per ecient unit of labor is positively correlatedwith capital outows.[...]