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The authors study how financial market efficiency affects a measure of diversification of output across industrial sectors borrowed from the portfolio allocation literature. Using data on sector-level value added for a wide cross section of countries and for various levels of disaggregation, they construct a benchmark measure of diversification as the set of allocations of aggregate output across industrial sectors which minimize the economy's long-term volatility for a given level of long-term growth. They find that financial markets increase substantially the speed with which the observed sectoral allocation of output converges towards the optimally diversified benchmark.
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