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Are Momentum Profits Robust to Trading Costs?

Author

Listed:
  • Robert A. Korajczyk

    (Northwestern University)

  • Ronnie Sadka

    (Northwestern University)

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.

Suggested Citation

  • Robert A. Korajczyk & Ronnie Sadka, 2003. "Are Momentum Profits Robust to Trading Costs?," Finance 0308004, University Library of Munich, Germany.
    • 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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    Cited by:

    1. Vega, Clara, 2006. "Stock price reaction to public and private information," Journal of Financial Economics, Elsevier, vol. 82(1), pages 103-133, October.

    More about this item

    Keywords

    Momentum strategies; Transaction costs; Price impact; Optimal trading; Market efficiency;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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