Execution of Portfolio Decisions

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passthismofo

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Simple stuff but worth knowing. Probably already on AF, but I was reviewing the formulas and thought might as well post it for others.
Mid Quote: (Inside Bid+Inside Ask)/2
Effective Spread:
Buy Order = 2*(Execution Price-Mid Quote)
Sell Order = 2*(Mid Quote-Execution Price)
IMPLEMENTATION SHORTFALL
1) Explicit costs=commission/paper portfolio
2) Delay Cost=(Decision Price-Benchmark Price)/Benchmark Price * % Filled
3) Realized Loss/Gain=(Execution Price-Decision Price)/Benchmark Price * % Filled
4) Opportunity Cost=(Closing Price-Benchmark Price)/Benchmark Price * % Unfilled
 
thanks, there’s a killer EOC question with the trade is executed two consecutive days and you have to use two different benchmark prices. Reviewing it now.
 
Yuck! I’ll have to take a look at that. Thx for pointing it out hot!
 
so you have to use mid-quote.
If you delay two days, which one do you use?
 
Draw a timeline and the questions become easy. I would love to see one of these on the exam.
 
mcpass Wrote:
——————————————————-
> so you have to use mid-quote.
>
> If you delay two days, which one do you use?
Benchmark price is always price. Never use quotes.
Remember that the reason you are doing this is to calculate costs. Bid/Ask spreads are a form of cost and the paper portfolio is subject to zero costs.
 
IS(implementation shortfall) =
(gain on paper portfolio - gain on real portfolio)/(initial investment in paper portfolio)
VWAP is a price, IS is a percentage.
Both are a measure of transaction cost.
“Surprisingly”, both become algorithmic trading strategies.
One is simple logical participation strategy, the other is IS strategy.
VWAP can be gamed, so it’s not informative for traders who dominates. It does not account for delayed cost and missed trade opportunity.
So we have IS, which solves the problem of VWAP. But it’s unfamiliar to traders(doubt it), and requires considerable data and analysis.
Overall, Is for small, urgent trade, which is usually traded early in the day to minimize opportunity cost. For illiquid stock and large trade, use broker.
What’s the best execution? It depends on the investment decision, circumstance and etc.
Regarding to ethics in trading. 1) fallen commission: traders shift cost to implicit cost. 2) electronic trading provide more anonymity: buy-side and sell-side traders become more adversarial.
 
Market Quality: assurity of completion, transparency, and liquidity.
Liquid Market: low bid-ask Spread, Deep, and Resilient.
Factors to make Market Liquid:
-many buyers/sellers, diversity of opinion(investors)
-convenience(electronic platform)
-market integrity
 
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