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.