AgPa #46: Transaction Costs and Capacities of Factor Strategies

Transaction Costs of Factor-Investing Strategies (2019)
Feifei Li, Tzee-Man Chow, Alex Pickard, Yadwinder Garg
Financial Analysts Journal 75(2), 47-61, URL

In this week’s AGNOSTIC paper, the authors develop a transaction cost model and use it to estimate the capacity of the major factors. There are many ways to define capacity in more detail, but the general idea is quite simple. It is the amount of money you can invest in a profitable strategy before you move prices too much and lose your advantage. Unfortunately, what theoretically sounds simple and intuitive is actually quite difficult to estimate in practice…

  • Implementation costs depend on tilt, turnover, and execution speed
  • Capacities of factors for a maximum cost of 0.5% per year
  • There is not yet a consensus on factor capacities

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AgPa #29: Cost-Mitigation Techniques

Comparing Cost-Mitigation Techniques (2019)
Robert Novy-Marx, Mihail Velikov
Financial Analysts Journal 75(1), 85-102, URL/SSRN

This week’s AGNOSTIC Paper examines three techniques to mitigate trading costs of systematic equity strategies and compares them by after-cost performance. The empirical evidence clearly speaks for the application of more sophisticated trading rules (Technique #3)…

  • Trading costs decreased but are still important
  • Technique #1: focus on “cheap-to-trade” securities
  • Technique #2: rebalance less frequently
  • Technique #3: create better trading rules
  • Value- versus equal-weighted portfolios

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AgPa #25: The Economics of High-Frequency-Trading

The Economics of High-Frequency Trading: Taking Stock (2016)
Albert J. Menkveld
Annual Review of Financial Economics, Vol. 8, 1-24, URL/SSRN

This week’s AGNOSTIC Paper examines once again a somewhat controversial topic: high frequency trading. The (public) image of HFTs is quite mixed with a clear tendency towards negative. However, an open-minded and scientific analysis suggests that we are probably better off with HFTs than without them…

  • Trading costs strongly decreased between 2001 and 2011
  • HFTs are fast, well-informed, and often market makers
  • Order-preying and arm’s races – it’s not all good
  • The benefits seem to outweigh the costs

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AgPa #22: Gamification of Trading

Does Gamified Trading Stimulate Risk Taking? (2021)
Philipp Chapkovski, Mariana Khapko, Marius Zoican
Swedish House of Finance Research Paper No. 21-25 via SSRN

Online brokers (Robinhood & Co.) are without question important financial innovations. They offer de-facto free trading and save investors a lot of fees. But they also leverage technology to encourage people to do more transactions. An important part of this is gamification and this week’s AGNOSTIC Paper examines that issue with a pretty cool experiment…

  • Gamification encourages investors to take more risk
  • Inexperienced investors without financial knowledge are most vulnerable

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Report Analytics USA #2

This post contains a lot of unsexy calculations and is fairly technical. But (in my opinion) there are some very interesting results. Not just for my particular strategy but for everyone who is active on Wikifolio.

First. Overall and especially after costs, my two Wikifolios weren’t a good alternative to a standard ETF on the S&P 500 index (from inception to March 11, 2022). To my defense, however, I stressed several times that the two Wikifolios are just a real-world test of my master thesis and I never marketed them as investments.

Second. I still believe that Wikifolio is a great platform to test strategies like mine, but it is not perfect. There are annoying technical issues, pretty high fees, and significant indirect trading costs. Depending on the liquidity of the stock, bid-ask-spreads and/or unfavorable FX rates amount to 40-80 basis points per transaction on average.

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