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Another look at trading costs and short-term reversal profits

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  • de Groot, Wilma
  • Huij, Joop
  • Zhou, Weili
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    Abstract

    Several studies report that abnormal returns associated with short-term reversal investment strategies diminish once trading costs are taken into account. We show that the impact of trading costs on the strategies’ profitability can largely be attributed to excessively trading in small cap stocks. Limiting the stock universe to large cap stocks significantly reduces trading costs. Applying a more sophisticated portfolio construction algorithm to lower turnover reduces trading costs even further. Our finding that reversal strategies generate 30–50 basis points per week net of trading costs poses a serious challenge to standard rational asset pricing models. Our findings also have important implications for the understanding and practical implementation of reversal strategies.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 36 (2012)
    Issue (Month): 2 ()
    Pages: 371-382

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    Handle: RePEc:eee:jbfina:v:36:y:2012:i:2:p:371-382

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    Web page: http://www.elsevier.com/locate/jbf

    Related research

    Keywords: Market efficiency; Anomalies; Short-term reversal; Portfolio construction; Market impact; Transaction costs; Liquidity;

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    Cited by:
    1. Blitz, David & Huij, Joop & Lansdorp, Simon & Verbeek, Marno, 2013. "Short-term residual reversal," Journal of Financial Markets, Elsevier, vol. 16(3), pages 477-504.
    2. de Groot, Wilma & Pang, Juan & Swinkels, Laurens, 2012. "The cross-section of stock returns in frontier emerging markets," Journal of Empirical Finance, Elsevier, vol. 19(5), pages 796-818.
    3. Yao, Yaqiong, 2012. "Momentum, contrarian, and the January seasonality," Journal of Banking & Finance, Elsevier, vol. 36(10), pages 2757-2769.

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