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

25 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. Adopting a mean-variance portfolio optimization problem, we show that including a transaction cost variance term can significantly impact the associated portfolios' performances. Transaction cost variance is estimated based on a transaction cost model constructed using proprietary data from a large institutional investment manager company. Using a standard time-series model setup for returns, we show that considering transaction cost variance leads to improved net risk-adjusted performance.

Keywords: Portfolio optimization, Implementation Shortfall, Time-series models. JEL Classification: C01, C32, C51, C52, C61, G11, G12

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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