44 Pages Posted: 15 May 2010 Last revised: 26 Jul 2011
Date Written: July 1, 2011
Several studies report that abnormal returns associated with short-term reversal investment strategies diminish once transaction costs are taken into account. We show that the impact of transaction 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 to 50 basis points per week net of transaction 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.
Keywords: market efficieny, anomalies, short-term reversal, portfolio construction, market impact, transaction costs, liquidity
JEL Classification: G11, G12, G14
Suggested Citation: Suggested Citation
de Groot, Wilma and Huij, Joop and Zhou, Weili, Another Look at Trading Costs and Short-Term Reversal Profits (July 1, 2011). Available at SSRN: https://ssrn.com/abstract=1605049 or http://dx.doi.org/10.2139/ssrn.1605049