The Journal of Finance

The Journal of Finance publishes leading research across all the major fields of finance. It is one of the most widely cited journals in academic finance, and in all of economics. Each of the six issues per year reaches over 8,000 academics, finance professionals, libraries, and government and financial institutions around the world. The journal is the official publication of The American Finance Association, the premier academic organization devoted to the study and promotion of knowledge about financial economics.

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Model Comparison with Transaction Costs

Published: 03/20/2023   |   DOI: 10.1111/jofi.13225

ANDREW DETZEL, ROBERT NOVY‐MARX, MIHAIL VELIKOV

Failing to account for transaction costs materially impacts inferences drawn when evaluating asset pricing models, biasing tests in favor of those employing high‐cost factors. Ignoring transaction costs, Hou, Xue, and Zhang (2015, Review of Financial Studies, 28, 650–705) q‐factor model and Barillas and Shanken (2018, TheJournal of Finance, 73, 715–754) six‐factor models have high maximum squared Sharpe ratios and small alphas across 205 anomalies. They do not, however, come close to spanning the achievable mean‐variance efficient frontier. Accounting for transaction costs, the Fama and French (2015, Journal of Financial Economics, 116, 1–22; 2018, Journal of Financial Economics, 128, 234–252) five‐factor model has a significantly higher squared Sharpe ratio than either of these alternative models, while variations employing cash profitability perform better still.

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