The Relevance of Information and Trading Costs in Explaining Momentum Profits: Evidence from Optioned and Non-Optioned Stocks

Abstract

Considerable evidence from a plethora of countries suggests that momentum strategies generate profits. These have been difficult to rationalize and evidence on the sources of such profitability is inconclusive.We use a sample of optioned stocks that are very liquid and large and have fewer short sales constraints, and we compare our results with control samples of non optioned stocks chosen on the basis of market value, turnover and bid–ask spread. The sample characteristics, and the fact that derivatives improve the impounding of information into prices, enable us to draw conclusions about the causes of momentum profits. While we find that short sales constraints are not the major driver of profitability and that most momentum profits disappear using two transactions costs measures of the bid–ask spread, one not previously used, the persistence of some momentum profits indicates that the market under reacts even to the most publicly available information.

Keywords: Momentum, Information, Bid–ask spread, Options

JEL Classification: G1, G14