Capital mobility and the long-run return–risk trade-offs of industry portfolios

Jia Chen; Xin Xu; Tong Yao

doi:10.1016/j.jempfin.2022.11.004

Back

Capital mobility and the long-run return–risk trade-offs of industry portfolios

Journal article

Peer reviewed

Capital mobility and the long-run return–risk trade-offs of industry portfolios

Jia Chen, Xin Xu and Tong Yao

Journal of empirical finance, Vol.70, pp.123-143

01/2023

DOI: 10.1016/j.jempfin.2022.11.004

View Online

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 trade-off in the financial market. •We study the empirical asset pricing implications of capital mobility across industries.•We find that the Sharpe ratios are equal across industry portfolios over the long run.•We find that capital investments and industry entries/exits respond to industry Sharpe ratios.•We rationalize the maximum diversification investment strategy based on equalized industry Sharpe ratios.

Industry portfolio

Investment-based asset pricing

Maximum diversification strategy

Q-factors

Sharpe ratio

Details

Title: Subtitle: Capital mobility and the long-run return–risk trade-offs of industry portfolios
Creators: Jia Chen - Peking University
Xin Xu - University of Finance and Economics
Tong Yao - Tippie College of Business, University of Iowa, United States of America
Resource Type: Journal article
Publication Details: Journal of empirical finance, Vol.70, pp.123-143
Publisher: Elsevier B.V
DOI: 10.1016/j.jempfin.2022.11.004
ISSN: 0927-5398
eISSN: 1879-1727
Grant note: DOI: 10.13039/501100001809, name: National Natural Science Foundation of China, award: 71403010
Language: English
Date published: 01/2023
Academic Unit: Finance
Record Identifier: 9984380404502771

Metrics

2 Record Views