Agency Costs of Institutional Trading

45 Pages Posted: 26 Nov 2006

See all articles by Roger M. Edelen

Roger M. Edelen

Virginia Tech

Gregory B. Kadlec

Virginia Polytechnic Institute & State University - Pamplin College of Business

Date Written: November 25, 2006

Abstract

Under the typical institutional trading arrangement a portfolio manager makes the trade decision and a trading desk executes the trade, with execution performance evaluated against a benchmark such as the volume weighted average price (VWAP). We show that this trading arrangement provides incentives to the trader that are at odds with the objectives of the portfolio manager. Specifically, traders maintain a relatively low ask quote during rising markets to expedite sell trades and a relatively high bid quote during falling markets to expedite buy trades. This process inhibits the security's natural tendency to rise (or fall) with the market. We provide empirical evidence of several properties of price-adjustment delays that are consistent with this model.

Keywords: Price adjustment delays, institutional investing, compensation

JEL Classification: G14, G23

Suggested Citation

Edelen, Roger M. and Kadlec, Gregory B., Agency Costs of Institutional Trading (November 25, 2006). Available at SSRN: https://ssrn.com/abstract=947034 or http://dx.doi.org/10.2139/ssrn.947034

Roger M. Edelen (Contact Author)

Virginia Tech ( email )

1016 Pamplin Hall (0221)
Blacksburg, VA 24060-0221
United States

Gregory B. Kadlec

Virginia Polytechnic Institute & State University - Pamplin College of Business ( email )

1016 Pamplin Hall
Blacksburg, VA 24061
United States
540-231-4316 (Phone)

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