Are Momentum Profits Robust to Trading Costs?, Journal of Finance
We test whether momentum-based strategies remain profitable after considering market frictions induced by trading. Intra-day data are used to estimate alternative measures of proportional (spread) and non-proportional (price impact) trading costs. A cross-sectional model of the relation between trading costs and firm characteristics is used to predict costs out-of-sample. The price impact models imply that abnormal returns to portfolio strategies decline with portfolio size. We calculate break-even fund sizes which lead to zero abnormal returns. In addition to commonly studied 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: conservatively, $5 billion or more (relative to December 1999 market capitalization) may be invested in these momentum-based strategies before the apparent profit opportunities vanish.
Robert Korajczyk, Ronnie Sadka
Korajczyk, Robert, and Ronnie Sadka. 2004. Are Momentum Profits Robust to Trading Costs?. Journal of Finance. 59(3): 1039-1082.LINK