Capital Mobility and the Long-Run Return-Risk Trade-Offs of Industry Portfolios
71 Pages Posted: 3 Feb 2018 Last revised: 25 Jan 2021
Date Written: January 24, 2021
Capital mobility may equalize investment opportunities across industries and cause the return-risk trade-offs of industry portfolios to converge. We show that over a long sample period, value-weighted industry portfolios using various classifications have Sharpe ratios statistically indistinguishable from each other. We further show that industry Sharpe ratios exhibit mean-reversion that can be attributed to cross-industry capital mobility. An investment strategy explicitly based on equalized industry Sharpe ratios significantly outperforms the market. Finally, we show that equalized industry Sharpe ratios may be consistent with the return-risk trade-off under a specific stochastic discount factor model.
Keywords: Industry Portfolio, Sharpe Ratio, Maximum Diversification Strategy
JEL Classification: G11, G12, G19
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