Do You Really Know Your P&L? The Importance of Impact-Adjusting the P&L

24 Pages Posted: 23 Jan 2023

See all articles by Petter N. Kolm

Petter N. Kolm

New York University (NYU) - Courant Institute of Mathematical Sciences

Kevin Webster

Columbia University

Date Written: January 19, 2023

Abstract

In this article, we examine the practice of evaluating trading and portfolio performance using accounting P&L, which values positions based on current market prices. We demonstrate that this method is biased due to the price impact from trading, and can give the impression of profits when there is none, even after accounting for closing costs. Instead, we propose using fundamental P&L, which adjusts market values for price impact, as a more accurate representation of investment performance. We provide both theoretical and practical evidence to support this claim and show that the difference between accounting and fundamental P&L, known as the trading footprint, can be significant in common trading scenarios. We close the article with a number of practical implications and recommendations for market practitioners, regulators, and senior management when evaluating investment performance.

Keywords: Algorithmic trading, Best execution, Liquidity risk, Optimal execution, Portfolio management, Price impact, Scenario analysis, Trading, Trading footprint

JEL Classification: C51, C53, C61, G10, G11, G12

Suggested Citation

Kolm, Petter N. and Webster, Kevin, Do You Really Know Your P&L? The Importance of Impact-Adjusting the P&L (January 19, 2023). Available at SSRN: https://ssrn.com/abstract=4331027 or http://dx.doi.org/10.2139/ssrn.4331027

Petter N. Kolm (Contact Author)

New York University (NYU) - Courant Institute of Mathematical Sciences ( email )

251 Mercer Street
New York, NY 10012
United States

Kevin Webster

Columbia University ( email )

3022 Broadway
New York, NY 10027
United States

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