A reappraisal of the allocation puzzle through the portfolio approach

► We perform a capital flow accounting exercise using the neoclassical growth model. ► The standard model is slightly extended to account for investment risk. ► This extension explains the positive correlation between capital outflows and growth. ► The capital wedge (distortions on the return to capital) is key to obtain this result. ► Global imbalances can be explained by the relatively low capital wedge in Asia.