Several studies report that abnormal returns associated with short-term reversal investment strategies diminish once trading costs are taken into account. We show that the impact of trading costs on the strategies' profitability can largely be attributed to excessively trading in small cap stocks. 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 30-50 basis points per week net of trading 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.

Additional Metadata
Keywords Anomalies, Liquidity, Market efficiency, Market impact, Portfolio construction, Short-term reversal, Transaction costs
JEL Portfolio Choice; Investment Decisions (jel G11), Asset Pricing (jel G12), Information and Market Efficiency; Event Studies (jel G14)
Persistent URL dx.doi.org/10.1016/j.jbankfin.2011.07.015, hdl.handle.net/1765/25718
Series ERIM Top-Core Articles
Journal Journal of Banking & Finance
Note Includes Accepted Author's manuscript
Citation
de Groot, W.A, Huij, J.J, & Zhou, W. (2012). Another look at trading costs and short-term reversal profits . Journal of Banking & Finance, 36(2), 371–382. doi:10.1016/j.jbankfin.2011.07.015