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Another look at trading costs and short-term reversal profits

Another look at trading costs and short-term reversal profits

01-07-2011 | Research

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.

  • Joop  Huij
    Joop
    Huij
    Head of Factor Investing Equities and Factor Index Research
  • Wilma de Groot, PhD
    Wilma
    de Groot, PhD
    Head of Core Quant Equities
  • Weili  Zhou
    Weili
    Zhou
    Head of Quant Equity Research

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.

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