Sectoral Diversification as Insurance against Economic Instability

This paper examines the extent to which sectoral diversification can act as an insurance mechanism against fluctuations in regional gross value added growth rates. I apply portfolio theory to the growth-instability properties of German districts. Furthermore, I define a comprehensive diversification measure and use Stochastic Frontier Analysis in order to estimate whether diversification allows regions to achieve more efficient growth-instability combinations, i.e., greater stability at given levels of economic growth. The results confirm that diversification does generate such effects. Spatial interactions do also play a role: The effects are less pronounced for regions whose economic performance is mainly driven by the surrounding regions.