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Another look at trading costs and short-term reversal profits

Author

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

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.

Suggested Citation

  • de Groot, Wilma & Huij, Joop & Zhou, Weili, 2012. "Another look at trading costs and short-term reversal profits," Journal of Banking & Finance, Elsevier, vol. 36(2), pages 371-382.
  • Handle: RePEc:eee:jbfina:v:36:y:2012:i:2:p:371-382
    DOI: 10.1016/j.jbankfin.2011.07.015
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    Citations

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    Cited by:

    1. Petri Jylhä & Kalle Rinne & Matti Suominen, 2014. "Do Hedge Funds Supply or Demand Liquidity?," Review of Finance, European Finance Association, vol. 18(4), pages 1259-1298.
    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. Barrot, Jean-Noel & Kaniel, Ron & Sraer, David, 2016. "Are retail traders compensated for providing liquidity?," Journal of Financial Economics, Elsevier, vol. 120(1), pages 146-168.
    4. Roy L. Hayes & Jingwei Wu & Ruijra Chaysiri & Jean Bae & Peter A. Beling & William T. Scherer, 2016. "Effects of time horizon and asset condition on the profitability of technical trading rules," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 40(1), pages 41-59, January.
    5. Blitz, David & Huij, Joop & Lansdorp, Simon & Verbeek, Marno, 2013. "Short-term residual reversal," Journal of Financial Markets, Elsevier, vol. 16(3), pages 477-504.
    6. repec:eee:finana:v:56:y:2018:i:c:p:181-192 is not listed on IDEAS
    7. repec:bla:eufman:v:22:y:2016:i:2:p:193-234 is not listed on IDEAS
    8. repec:eee:finlet:v:23:y:2017:i:c:p:114-120 is not listed on IDEAS
    9. Yao, Yaqiong, 2012. "Momentum, contrarian, and the January seasonality," Journal of Banking & Finance, Elsevier, vol. 36(10), pages 2757-2769.
    10. repec:kap:fmktpm:v:31:y:2017:i:2:d:10.1007_s11408-017-0288-x is not listed on IDEAS
    11. Kees G. Koedijk & Alfred M.H. Slager & Philip A. Stork, 2016. "Investing in Systematic Factor Premiums," European Financial Management, European Financial Management Association, vol. 22(2), pages 193-234, March.
    12. Friedrich-Carl Franz & Tobias Regele, 2016. "Beating the DAX, MDAX, and SDAX: investment strategies in Germany," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 30(2), pages 161-204, May.
    13. Roy Hayes & Jingwei Wu & Ruijra Chaysiri & Jean Bae & Peter Beling & William Scherer, 2016. "Effects of time horizon and asset condition on the profitability of technical trading rules," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 40(1), pages 41-59, January.
    14. repec:eee:reveco:v:53:y:2018:i:c:p:168-184 is not listed on IDEAS

    More about this item

    Keywords

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

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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