What You See Is Not What You Get: The Costs of Trading Market Anomalies
65 Pages Posted: 12 Sep 2017 Last revised: 26 Sep 2018
Date Written: September 25, 2018
Is there a gap between the profitability of a trading strategy “on paper” and that which is achieved in practice? We answer this question by developing two new techniques to measure the real-world implementation costs of financial market anomalies. The first method extends Fama-MacBeth regressions to compare the on-paper returns to factor exposures with those achieved by mutual funds. The second method estimates average return differences between stocks and mutual funds matched on risk characteristics. Unlike existing approaches, these techniques deliver estimates of implementation costs without estimating parametric microstructure models from trading data or explicitly specifying factor trading strategies. After accounting for implementation costs, typical mutual funds earn low returns to value and no returns to momentum.
Keywords: Trading Costs, Performance Evaluation, Mutual Funds, Market Efficiency
JEL Classification: G12, G14, G23
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