Title: Model comparison with transaction costs
Authors: Andrew Andrew Detzel - University of Denver (United States) [presenting]
Mihail Velikov - Pennsylvania State University (United States)
Robert Novy-Marx - University of Rochester (United States)
Abstract: Failing to account for transaction costs materially impacts inferences drawn when evaluating asset pricing models, biasing tests in favour of those employing high-cost factors. Ignoring transaction costs, certain q-factor and six-factor models have high maximum squared Sharpe ratios and small alphas across 120 anomalies. They do not, however, come close to spanning the achievable mean-variance efficient frontier. Accounting for transaction costs, the Fama and French five-factor model has a significantly higher squared Sharpe ratio than either of these alternative models. At the same time, variations employing cash profitability perform better still. More generally, these results highlight the importance of incorporating real-world concerns into financial research.