Monumentum profits and trading costs

This paper investigates whether momentum strategies remain profitable, when the trading costs, including price impact are considered. Using French enterprises quoted over the period 1995- 2004, momentum strategy is applied for various formation (6 and 12 months) and holding (1, 3, 6, 9, 12 months) periods. Performance of momentum strategy is evaluated after taking into account alternative measures of transaction costs. In order to estimate measures of liquidity, trading cost estimates are adjusted to a set of predetermined firm-specific variables. Two approaches were followed to estimate the returns of the momentum strategy, net of the trading costs. First we com- pared the returns of the winner minus loser portfolio to the respective transaction cost estimates. Second, we estimate the abnormal returns of Fama and French three factors model [6]. We find that the returns associated with relative strength investing strategies exceed three measures of trading costs: effective spread, price impact measures of Breen et al. [2] and Glosten et al. [9] cost models. For proportional trading costs (quoted spread and effective spread), the estimated abnormal return imply that proportional spreads do not eliminate the statistically significance of momentum profits. For non proportional trading costs (price impact models), the performance of the trading strategy declines with portfolio size. We estimate the abnormal returns for different levels of initial investment. For Breen et al. specification, we find that for the major break even fund sizes momentum strategies perform better post price impact. For Glosten et al. specification, we find that abnormal return remains positive for all levels of initial investment