Date: November 18, 2011 Petter Kolm, CIMS
Title: The Cost of Trading Factors
Numerous studies document a number of trading strategies are profitable.
Other studies show that these findings do not hold because market frictions
such as transaction costs and market impact will subvert the profit earned
on these trading studies. We examine the performance of 22 single factor and
multi-factor equity trading strategies including the effects of market
frictions such as financing costs, explicit trading costs, and implicit
trading costs. The implicit trading costs are cultivated using a market
impact model. We find the profitability of trading strategies is diminished
significantly, particularly for larger amounts of assets under management.
Using cost aware portfolio construction, we develop a methodology to
replicate these trading strategies while incorporating transaction costs.
With this methodology, we implement trading strategies that better retain
their profitability after transaction costs and market impact.