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

63 Pages Posted: 3 Feb 2018 Last revised: 24 Sep 2018

See all articles by Jia Chen

Jia Chen

Peking University - Guanghua School of Management

Xin Xu

Peking University - Guanghua School of Management

Tong Yao

University of Iowa - Henry B. Tippie College of Business

Date Written: September 11, 2018

Abstract

Capital mobility may equalize investment opportunities across industries, and further, may cause the return-risk trade-offs of industry equity portfolios to converge. We show that over a long period from 1926 to 2014, value-weighted industry portfolios based on Fama-French 5, 10, 12, 17, 30, and 49 industry classifications have Sharpe ratios that are statistically indistinguishable from each other. We further show that Sharpe ratios of industry portfolios have a mean-reversion component and that the mean reversion of industry Sharpe ratios can be attributed to cross-industry capital mobility -- industries with higher Sharpe ratios tend to have higher capital investments subsequently. Finally, we examine the performance of an investment strategy that is explicitly based on the assumption of equal Sharpe ratios across industry portfolios. Various versions of this strategy significantly outperform the market portfolio.

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 (September 11, 2018). Available at SSRN: https://ssrn.com/abstract=3110447 or http://dx.doi.org/10.2139/ssrn.3110447

Jia Chen

Peking University - Guanghua School of Management ( email )

Peking University
Beijing, Beijing 100871
China

Xin Xu

Peking University - Guanghua School of Management ( email )

Beijing
China

Tong Yao (Contact Author)

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

Acquisitions
5020 Main Library
Iowa City, IA 52242-1000
United States

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