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Are Momentum Profits Robust to Trading Costs?

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Author Info
Robert A. Korajczyk (Northwestern University)
Ronnie Sadka (Northwestern University)

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Abstract

We test whether momentum-based strategies remain profitable after considering market frictions induced by trading. Intra-day data are used to estimate alternative measures of proportional (spread) and non- proportional (price impact) trading costs. A cross-sectional model of the relation between trading costs and firm characteristics is used to predict costs out-of-sample. The price impact models imply that abnormal returns to portfolio strategies decline with portfolio size. We calculate break-even fund sizes which lead to zero abnormal returns. In addition to commonly studied equal- and value-weighted momentum strategies, we derive a liquidity-weighted strategy designed to reduce the cost of trades. Equal-weighted strategies perform the best before trading costs and the worst after trading costs. Liquidity-weighted and hybrid liquidity/value-weighted strategies have the largest break-even fund sizes: conservatively, $5 billion or more (relative to December 1999 market capitalization) may be invested in these momentum-based strategies before the apparent profit opportunities vanish.

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Publisher Info
Paper provided by EconWPA in its series Finance with number 0308004.

Download reference. The following formats are available: HTML (with abstract), plain text (with abstract), BibTeX, RIS (EndNote, RefMan, ProCite), ReDIF
Length: 47 pages
Date of creation: 07 Aug 2003
Date of revision:
Handle: RePEc:wpa:wuwpfi:0308004

Note: Type of Document - Acrobat PDF; prepared on Dell PC; to print on Any; pages: 47; figures: included
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Web page: http://129.3.20.41

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Related research
Keywords: Momentum strategies; Transaction costs; Price impact; Optimal trading; Market efficiency;

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Find related papers by JEL classification:
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies

Cited by:
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  1. Benjamin Chabot & Eric Ghysels & Ravi Jagannathan, 2008. "Price Momentum In Stocks: Insights From Victorian Age Data," NBER Working Papers 14500, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Lee, Kuan-Hui, 2005. "The World Price of Liquidity Risk," Working Paper Series 2006-10, Ohio State University, Charles A. Dice Center for Research in Financial Economics. [Downloadable!]
  3. Menkhoff, Lukas & Schmeling, Maik, 2006. "A Prospect-Theoretical Interpretation of Momentum Returns," Diskussionspapiere der Wirtschaftswissenschaftlichen Fakultät der Universität Hannover dp-335, Universität Hannover, Wirtschaftswissenschaftliche Fakultät. [Downloadable!]
    Other versions:
  4. Manuel Ammann & Michael Verhofen, 2006. "The Effect of Market Regimes on Style Allocation," Financial Markets and Portfolio Management, Springer, vol. 20(3), pages 309-337, September. [Downloadable!] (restricted)
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