48 Pages Posted: 29 May 2003
In markets with trading friction, the incorporation of information into market prices can be substantially delayed through a weakening of the arbitrage process. We re-examine the profitability of relative-strength, or momentum, trading strategies (buying past strong performers and selling past weak performers). We find that standard relative-strength strategies require frequent trading in disproportionately high-cost securities so that trading costs prevent profitable strategy execution. In the cross section, we find that those stocks that generate large momentum returns are precisely those stocks with high trading costs. We conclude that the magnitude of the abnormal returns associated with these trading strategies creates an illusion of profit opportunity when, in fact, none exists.
Keywords: Trading Strategies, Momentum, Transaction Costs
JEL Classification: G14
Suggested Citation: Suggested Citation
Lesmond, David A. and Schill, Michael J. and Zhou, Chunsheng, The Illusory Nature of Momentum Profits. Journal of Financial Economics, Vol. 71, No. 2, pp. 349-380. Available at SSRN: https://ssrn.com/abstract=256926 or http://dx.doi.org/10.2139/ssrn.256926