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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

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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    Cited by:

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    9. Martin H. Schmidt, 2017. "Trading strategies based on past returns: evidence from Germany," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 31(2), pages 201-256, May.
    10. Shuai Zhao & Yunhai Tong & Zitian Wang & Shaohua Tan, 2016. "Identifying Key Drivers of Return Reversal with Dynamical Bayesian Factor Graph," PLOS ONE, Public Library of Science, vol. 11(11), pages 1-20, November.
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    More about this item

    Keywords

    Market efficiency; Anomalies; Short-term reversal; Portfolio construction; Market impact; Transaction costs; Liquidity;
    All these keywords.

    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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