The relevance of information and trading costs in explaining momentum profits: Evidence from optioned and non-optioned stocks

Considerable evidence from many countries suggests momentum strategies generate profits. These have been difficult to rationalise and evidence on the sources of such profitability is inconclusive. We utilise a sample of optioned stocks, characterised by high liquidity, high market capitalisation and fewer short sales constraints and compare 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 underreacts even to the most publicly available information.