Trading Volume Alpha
Portfolio optimization focuses on risk and return prediction, yet implementation costs critically matter. Predicting trading costs is challenging because costs depend on trade size and trader identity, thus impeding a generic solution. We focus on a component of trading costs that applies universally – trading volume. Individual stock trading volume is highly predictable, especially with machine learning. We model the economic benefits of predicting volume through a portfolio framework that trades off tracking error versus net-of-cost performance – translating volume prediction into net-of-cost alpha. The economic benefits of predicting individual stock volume are as large as those from stock return predictability.
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