Are Momentum Profits Robust to Trading Costs?
Journal of Finance, Vol. 59, No. 3, pp. 1039-1082, June 2004
Posted: 29 Dec 2004
We test whether momentum strategies remain profitable after considering market frictions induced by trading. Intraday data are used to estimate alternative measures of proportional and non-proportional (price impact) trading costs. The price impact models imply that abnormal returns to portfolio strategies decline with portfolio size. We calculate break-even fund sizes that lead to zero abnormal returns. In addition to 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: $5 billion or more (relative to December 1999 market capitalization) may be invested in these momentum strategies before the apparent profit opportunities vanish.
Keywords: Momentum strategies, transaction costs, price impact, optimal trading, market efficiency
JEL Classification: G11, G14
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