The Capacity of Trading Strategies

50 Pages Posted: 27 Mar 2015 Last revised: 5 Feb 2019

See all articles by Maxime Bonelli

Maxime Bonelli

HEC Paris - Finance Department

Augustin Landier

HEC

Guillaume Simon

Capital Fund Management

David Thesmar

Massachusetts Institute of Technology (MIT) - Economics, Finance, Accounting (EFA)

Date Written: February 4, 2019

Abstract

Due to non-linear transaction costs, the fi nancial performance of a trading strategy decreases
with portfolio size. Using a dynamic trading model a la Garleanu and Pedersen (2013), we
derive closed-form formulas for the performance-to-scale frontier reached by competitive traders
endowed with a signal predicting stock returns. The decay with scale of the realized Sharpe
ratio is slower for strategies that (1) trade more liquid stocks (2) are based on signals that do
not fade away quickly and (3) have strong frictionless performance. We apply the framework to
four well-known strategies. The capacity of strategies has increased in the 2000s compared to
the 1990s due to increased liquidity. Because low volatility and past accounting profi tability are
persistent characteristics, strategies based on them are highly scalable, including in the mid-cap
range. When traders underestimate the number of competitors trading a similar signal, their
performance is strongly negatively impacted.

Keywords: trading costs, asset pricing anomalies, asset management, arbitrage

JEL Classification: G11, G12

Suggested Citation

Bonelli, Maxime and Landier, Augustin and Simon, Guillaume and Thesmar, David, The Capacity of Trading Strategies (February 4, 2019). HEC Paris Research Paper No. FIN-2015-1089. Available at SSRN: https://ssrn.com/abstract=2585399 or http://dx.doi.org/10.2139/ssrn.2585399

Maxime Bonelli

HEC Paris - Finance Department ( email )

France

Augustin Landier

HEC ( email )

France
+33630006051 (Phone)

HOME PAGE: http://https://sites.google.com/site/augustinlandier/

Guillaume Simon

Capital Fund Management ( email )

23 rue de l'Université
Paris, 75007
France

David Thesmar (Contact Author)

Massachusetts Institute of Technology (MIT) - Economics, Finance, Accounting (EFA) ( email )

77 Massachusetts Avenue
Cambridge, MA 02139-4307
United States
16172259767 (Phone)

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