Are Momentum Profits Robust to Trading Costs?

Robert Korajczyk and Ronnie Sadka
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Ronnie Sadka: Northwestern University

Finance from University Library of Munich, Germany

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.

Keywords: Momentum strategies; Transaction costs; Price impact; Optimal trading; Market efficiency (search for similar items in EconPapers)
JEL-codes: G11 G14 (search for similar items in EconPapers)
Pages: 47 pages
Date: 2003-08-07
Note: Type of Document - Acrobat PDF; prepared on Dell PC; to print on Any; pages: 47; figures: included
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Persistent link: https://EconPapers.repec.org/RePEc:wpa:wuwpfi:0308004

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