Capital Mobility and the Long-Run Return-Risk Trade-Offs of Industry Portfolios

71 Pages Posted: 3 Feb 2018 Last revised: 25 Jan 2021

See all articles by Jia Chen

Jia Chen

Peking University

Xin Xu

Guangdong University of Finance and Economics; Guangdong University of Finance and Economics - School of Finance

Tong Yao

University of Iowa - Henry B. Tippie College of Business

Date Written: January 24, 2021

Abstract

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

Suggested Citation

Chen, Jia and Xu, Xin and Yao, Tong, Capital Mobility and the Long-Run Return-Risk Trade-Offs of Industry Portfolios (January 24, 2021). Available at SSRN: https://ssrn.com/abstract=3110447 or http://dx.doi.org/10.2139/ssrn.3110447

Jia Chen

Peking University ( email )

5 Yiheyuan Road
Haidian District
Beijing, Beijing 100871
China

Xin Xu

Guangdong University of Finance and Economics ( email )

Room 339, the 2nd North Building
21th Luntou Road
Guangzhou, 510320
China

Guangdong University of Finance and Economics - School of Finance ( email )

Guagnzhou
China

Tong Yao (Contact Author)

University of Iowa - Henry B. Tippie College of Business ( email )

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