S16 Flashcards
effective spread for buy order =
2x ( execution - midquote)
effective spread for sell order =
2x ( midquote - execution )
as the traders agent, brokers do:
- represent the order
- find couterparties to the trade
- provide secrecy
- provide other services (record keeping, safe keeping, cash management) - but not liquidity which is the role of the DEALER
- support the market
liquid market has:
- abundance of buyers and sellers
- investor characteristics are diverse
- convenient location or trading plafrom
- integrity
execution costs :
explicit and implicit
explicit execution costs
commissions
taxes
stamp duties
fees
implicit execution costs
bid ask spread
market or price impact costs
opportunity costs
delay costs (slippage)
components of implementation shortfall
explicit costs
realized profit loss
delay or slippage cost
missed trade opportunity cost
implementation shortfall – realized profit/loss =
(exe - previous close) / decision * purchased / ordered
implementation shortfall – delay or slippage cost =
( previous close - decision ) / decision * purchased / ordered
implementation shortfall – missed opportunity
( cancelation - decision ) / decision * cancelled / ordered
implementation shortfall (paper) =
( paper portfolio gain - real portfolio gain ) / paper portfolio investment
advantages of volume weighted average price
- easily understood
- computationally simple
- can be applied quickly to enhance trading decisions
- most appropriate for comparing small trades in nontrending markets
disadv of volume weighted average price
- not informative for trades that dominate the trading volume
- can be gamed by traders
- does not evaluate delayed of unfilled orders
- does not account for market movements or trade volume
advantages of implementation shortfall
- PMs can see the cost of implemeting their ideas
- demos the tradeoff between quick execution and market impact
- decompose and identifies costs
- can be used in an optimizer to minimize trading costs
- not subject to gaming
disadv of implementation shortfall
may not be familiar to traders
requires considerable data and analysis
information motivated traders (motivation, needs, order)
possess time senzitive information
need quick execution
place market orderss
value motivated traders (motivation, needs, order)
security misvaluation
need good price
place limit order
liquidity motivated traders (motivation, needs, order)
reallocation and liquidity
need quick execution
place market orders
passive traders (motivation, needs, order)
reallocation and liquidity
need good price
place limit orders
trading tactics
liquidity at any cost costs are not important need trustworthy agent advertise to draw liquidity low cost whatever the liquidity
liquidity at any cost - trading tactics (+, -, motivation)
+quick certain execution
- high costs and leakage of info
motivation : information
costs are not important - trading tactics (+, -, motivation)
+quick certain execution
- loss of control of trade costs
motivations : diverse
need trustworthy agent - trading tactics (+, -, motivation)
+brokers use skill and time to obtain good price
- high commission and potential leakage
motivation : not information
advertise to draw liquidity - trading tactics (+, -, motivation)
+market determined price
- higher admin costs and possible front run
motivation : not information
low cost whatever the liquidity - trading tactics (+, -, motivation)
+ low trading costs
- uncertain timing and possibly trading into weakness
motivation : passive and value
algoritmic trading use
automated quantitative systems that utilize trading rules, benchmarks, and constraints
simple logical participation trading strategies seek to
trade with market flow so as to not becovme overly noticeable to the market and to minimize the market impact
4 characteristics of best execution
- cannot be judged independently of the investment decision
- cannot be known with certainty ex ante
- can be assessed only ex post
- relashionships and practices are intergral part of execution
bid ask sizes vs spread. market is of better quality if
sizes are larger and spread smaller
VWAP is close to trade price when
trader dominates the market
algoritmic trading should be avoided when
order is large and spread is wide
constant proportion portfolio insurance CPPI
target equities = M x (Portfolio value - floor value)
contstant mix is a conXXXXX strategy (Vaxis value of assets vs Haxis value of stock market
concave strategy - marginal profit smaller when stock market is moving up
CPPI is a conXXXXX strategy (Vaxis value of assets vs Haxis value of stock market
convex strategy - marginal profit larger when stock market is moving up
3 situations requiring rebalancing
changes in:
- investor circumstances
- economic./market conditions
- portfolio itself
risk related assumptions of the buyhold, constant mix and CPPI strategies
Buyhold passively assumes risk tolerance increasing with wealth
Constant mix - risk tolerance is constant regardles of wealth
CPPI - activelly assumes risk tolerance directly related to wealth
recommended re balancing range for volatile assets
narrow to allow quick detection and correction before they go further out of desired range
(n.b. do not worry about higher costs)
Correlation to the rest of portfolio - impact on allocation bands?
Higher correlation lowers probability of large divergences, so wide range ismacceptable.
Volatility of rest of the portfolio , impact on allocation range?
If rest of pf is volatile, narror range of allocation needed.
