Reading 23 - Practice Problem 17 - Help Needed

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OMGMileyCyrus

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Practice problem 17 in Reading 30 Execution of Portfolio Decisions asks us to recommend a trading tactic for two trades to be executed. For Trade A (with a low spread % of 0.03, a low average daily volume of 3%, and high urgency), the suggested answer is to use an implementation shortfall strategy. My initial thought was to use a volume weighted average price (VWAP) strategy as this was the strategy used in Exhibit 21 for a similar trade (ABC) with low average daily volume of 5% and low spread % of 0.05). The only different criteria is the urgency that is given to ABC in Exhibit 12 is low versus high in practice problem 17. Is the level of urgency the distinguishing characteristic that makes trade A in practice problem 17 implementation shortfall instead of VWAP? Am I missing anything else here?
Thanks!
OMGMileyCyrus
 
Yes, with high urgency trades should utilize IS while low urgency trades should utilize VWAP. This is because VWAP can be gamed due to the fact that missed trades are not accounted for in the cost, potentially motivating traders to wait until day’s end and then just execute whichever trades would make them look best. Both strategies are best used in analysis with a low b-a spread and low % of total trading volume being used, though IS works better (compared to VWAP) when the % of trading volume is larger.
 
So the urgency is the primary driver for the difference between them.
- Use IS when the urgency is high, i.e. you don’t want to miss out on the opportunity.
- Use VWAP, when the urgency is low
But for both you still need enough liquidity and the trading volume should be smaller than the average trading volume for the day correct?
 
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