Best Trend-following Strategy with Frictions?

Is there an optimal net (incorporating trading frictions) trend-following strategy for broad stock portfolios? In their November 2022 paper entitled “Optimal Trend-Following With Transaction Costs”, Valeriy Zakamulin and Javier Giner develop and test a simple model that incorporates short-term return persistence (trend) and trading frictions (half bid-ask spread, fees and impact of trading). Their trend-following strategy switches between a stock portfolio and the risk-free asset (Treasury bills). They model trend as typically positive, linearly decreasing daily return autocorrelations for lags up to 25 trading days. For empirical tests, they focus on small-capitalization U.S. stocks (bottom fifth of market capitalizations). Based on past studies, they test 1-way proportional trading frictions in the range 0% to 1%. Using theoretical analyses and daily returns for small stocks/Treasury bill yields during January 1952 through December 2021, they find that: (more…)