Cost of trading factor strategies

Abstract

Recent academic literature claims that style premia are not robust to trading costs. Several papers written by practitioners counter that the assumptions made by academics on how style portfolios rebalance are too conservative. In this paper we analyse the cost of trading factor strategies using a market impact model estimated from actual transactions data, realistic and multiple portfolio construction techniques and up-to-date data. Our results suggest that, for realistic portfolio sizes, the typical costs of rebalancing a single-factor strategy are unlikely to erode the factor premium.
 In addition, by building portfolios across different factors and with alternative portfolio construction techniques, we are able to assess the degree of similarity amongst strategies over time, which can be viewed as a measure of crowding. The properties of our new crowding indicator are illustrated through an extensive empirical investigation. We then assess its relation to volatility, liquidity and market impact and find that increases in our crowding measure tend to be followed by increases in the volatility of a strategy’s returns.