Implementation Shortfall with Transitory Price Effects
Appeared in David Easley, Marcos López de Prado, and Maureen O'Hara, 2013, editors, "High-Frequency Trading: New Realities for Traders, Markets and Regulators."
24 Pages Posted: 13 Mar 2018
Date Written: March 18, 2013
Regulators and some large investors have recently raised concerns about temporary or transitory volatility in highly automated financial markets. It is far from clear that high-frequency trading, fragmentation, and automation are contributing to transitory volatility, but some institutions complain that their execution costs are increasing. In this chapter, we introduce a methodology for decomposing the price process of a financial instrument into its permanent and transitory components, and we explore the insights from applying this methodology to execution cost measurement. Among other things, our methodology allows an institutional investor to accurately measure the contributions of transitory price movements to its overall trading costs. The methodology is particularly applicable to an investor that splits a large order into small pieces and executes it gradually over time.
Keywords: Implementation shortfall, volatility decomposition, institutional investor
JEL Classification: G23
Suggested Citation: Suggested Citation