Can The Size Premium Survive The Trading Costs Erosion? Transaction-Cost Estimation, Mitigation And Factor Performance In European Equities (2003-2023).

Abstract

This thesis investigates the impact of transaction costs on the net performance of equity portfolios, with a focus on factor-based strategies that aim to capture the size premium. While theoretical models often assume frictionless trading, real-world implementation is subject to significant trading costs that can erode returns and distort portfolio outcomes. Using a comprehensive dataset of European equities from 2003 to 2023, this study constructs portfolios sorted via Fama-French and DSN methodologies and adjusts their performance using two established transaction cost estimators: Roll’s implied spread and Hasbrouck’s Gibbs sampling method. The analysis reveals that transaction costs—especially when estimated conservatively—substantially diminish net returns, with DSN-based strategies exhibiting higher sensitivity due to deeper exposure to illiquid stocks. Furthermore, the study evaluates cost mitigation techniques, including lower rebalancing frequencies and banding strategies, to assess their effectiveness in preserving factor premia. Findings underscore the critical importance of incorporating realistic trading frictions in empirical asset pricing and demonstrate that certain portfolio construction and rebalancing approaches offer more resilience in preserving net performance.