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

67 Pages Posted: 3 Feb 2018 Last revised: 27 Aug 2021

See all articles by Jia Chen

Jia Chen

Peking University

Xin Xu

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

Tong Yao

University of Iowa - Henry B. Tippie College of Business

Date Written: August 23, 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 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. Its performance cannot be explained by the traditional empirical asset pricing models but is readily explained by the q-factor model. Our findings suggest that capital mobility and investment-based asset pricing have important implications on the long-run return-risk tradeoff in the financial market.

Keywords: Industry portfolio; Sharpe ratio; Maximum diversification strategy; Investment-based asset pricing; Q-factors

JEL Classification: G11, G12, G19

Suggested Citation

Chen, Jia and Xu, Xin and Xu, Xin and Yao, Tong, Capital Mobility and the Long-Run Return-Risk Trade-Offs of Industry Portfolios (August 23, 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 - School of Finance ( email )

Guagnzhou
China

Guangdong University of Finance and Economics ( email )

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

Tong Yao (Contact Author)

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

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