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Are Momentum Profits Robust to Trading Costs?

Author

Listed:
  • Robert A. Korajczyk

    (Northwestern University)

  • Ronnie Sadka

    (University of Washington)

Abstract

We test whether momentum strategies remain profitable after considering market frictions induced by trading. Intraday data are used to estimate alternative measures of proportional and non-proportional (price impact) trading costs. The price impact models imply that abnormal returns to portfolio strategies decline with portfolio size. We calculate break-even fund sizes that lead to zero abnormal returns. In addition to 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: $5 billion or more (relative to December 1999 market capitalization) may be invested in these momentum strategies before the apparent profit opportunities vanish. Copyright 2004 by The American Finance Association.

Suggested Citation

  • Robert A. Korajczyk & Ronnie Sadka, 2004. "Are Momentum Profits Robust to Trading Costs?," Journal of Finance, American Finance Association, vol. 59(3), pages 1039-1082, June.
  • Handle: RePEc:bla:jfinan:v:59:y:2004:i:3:p:1039-1082
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    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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