The risk of falling short: Implementation Shortfall variance in portfolio construction

29 Pages Posted: 30 Jan 2022

See all articles by Filip Basic

Filip Basic

Lancaster University - Department of Accounting and Finance

Alberto Martin-Utrera

Iowa State University

Ingmar Nolte

Lancaster University - Department of Accounting and Finance

Sandra Nolte (Lechner)

Lancaster University Management School

Date Written: January 25, 2022

Abstract

Transaction cost variance introduces a risk often neglected in portfolio optimization. We define a mean-variance portfolio optimization problem and show that including a transaction cost variance term significantly impacts the performance of these portfolios. Transaction cost variance is estimated based on a transaction cost model constructed using proprietary data from a large institutional money manager. Using a standard time-series models setup for our returns, we show that considering transaction cost variance leads to better performing portfolios. We further demonstrate the main contribution of transaction cost variance, which we show to have reduced transaction costs significantly.

Keywords: Portfolio optimization, Implementation Shortfall, Time-series models.

JEL Classification: C01, C32, C51, C52, C61, G11, G12

Suggested Citation

Basic, Filip and Martin-Utrera, Alberto and Nolte, Ingmar and Nolte (Lechner), Sandra, The risk of falling short: Implementation Shortfall variance in portfolio construction (January 25, 2022). Available at SSRN: https://ssrn.com/abstract=4017974 or http://dx.doi.org/10.2139/ssrn.4017974

Filip Basic (Contact Author)

Lancaster University - Department of Accounting and Finance ( email )

Lancaster, Lancashire LA1 4YX
United Kingdom

Alberto Martin-Utrera

Iowa State University ( email )

613 Wallace Road
Ames, IA 50011-2063
United States

Ingmar Nolte

Lancaster University - Department of Accounting and Finance ( email )

Lancaster, Lancashire LA1 4YX
United Kingdom

Sandra Nolte (Lechner)

Lancaster University Management School ( email )

Lancaster, Lancashire LA1 4YX
United Kingdom

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