Title: A TAXONOMY OF ANOMALIES AND THEIR TRADING COSTS
Authors: ROBERT NOVY-MARX, MIHAIL VELIKOV
Publication: THE REVIEW OF FINANCIAL STUDIES, 2016
#Research Questions: 1)What are the costs of trading the most important anomalies? 2)What is the capacity that each of these strategies has to attract new capital before it becomes unprofitable to marginal trading? 3) Are there effective transaction cost mitigation techniques?
#Academic Insight: 1) Transaction costs typically reduce value-weighted long/short strategies by 1% of the monthly one-sided turnover (i.e. for a strategy that turns over 20% per month, the spread will be at least 20 bps lower per month). Many of the strategies based on the anomalies studied ( at least those with turnover <50%) remain profitable but in all cases transaction costs significantly reduce their profitability and statistical significance. 2) Low turnover strategies tend to have higher capacities. The authors calculate $100 B + capacity for size, $50 B. for value and $5 B. for momentum. 3) A buy/hold spread that makes the criterion for entering into a position more stringent that the criteria for maintaining a position is the most effective cost mitigation technique for most of the anomalies studied.
#Application: Everywhere you turn there is hysteria over factor investing and smart beta. The incentives to develop these strategies are highly attractive, both in academia and the industry. This raises concern over data-snooping and therefore the probability of unacceptable performance. Investors need to be careful in doing their due diligence and require stringent econometric rigor when presented with backtest results.