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Article

Measuring and Modeling Execution Cost and Risk

Engle Robert, Ferstenberg Robert and Russell Jeffrey
The Journal of Portfolio Management Winter 2012, 38 (2) 14-28; DOI: https://doi.org/10.3905/jpm.2012.38.2.014
Engle Robert
is the Michael Armelino Professor of Finance in the Stern School of Business at New York University in New York, NY.
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  • For correspondence: rengle@stern.nyu.edu
Ferstenberg Robert
is a consultant residing in Concord, MA.
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  • For correspondence: robert.ferstenberg@gmail.com
Russell Jeffrey
is a professor of econometrics and statistics in the Booth School of Business at the University of Chicago in Chicago, IL.
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  • For correspondence: jeffrey.russell@chicagobooth.edu
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Abstract

Financial markets are considered to be liquid if a large quantity can be traded quickly and with minimal price impact. Although the idea of a liquid market involves both a cost as well as a time component, most measures of execution costs tend to focus on only a single number that reflects average costs and do not explicitly account for the temporal dimension of liquidity. In practice, trading takes time because larger orders are often broken up into smaller transactions or because of price limits. Recent work shows that the time taken to transact introduces a risk component in execution costs. In this setting, the decision can be viewed as a risk–reward trade-off faced by the investor who can solve for a mean-variance utility-maximizing trading strategy. Engle, Ferstenberg, and Russell introduce an econometric method to jointly model the expected cost and risk of the trade, thereby characterizing the mean-variance tradeoffs associated with different trading approaches, given market and order characteristics. They apply their methodology to a novel dataset and show that the risk component is a nontrivial part of the transaction decision.

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The Journal of Portfolio Management: 38 (2)
The Journal of Portfolio Management
Vol. 38, Issue 2
Winter 2012
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Measuring and Modeling Execution Cost and Risk
Engle Robert, Ferstenberg Robert, Russell Jeffrey
The Journal of Portfolio Management Jan 2012, 38 (2) 14-28; DOI: 10.3905/jpm.2012.38.2.014

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Measuring and Modeling Execution Cost and Risk
Engle Robert, Ferstenberg Robert, Russell Jeffrey
The Journal of Portfolio Management Jan 2012, 38 (2) 14-28; DOI: 10.3905/jpm.2012.38.2.014
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  • Article
    • Abstract
    • CHOICE OF TRADING STRATEGY
    • MEASURING ORDER EXECUTION COST AND RISK
    • THE DATA
    • MODELING THE EXPECTED COST AND RISK OF ORDER EXECUTION
    • EMPIRICAL RESULTS
    • IS THE RISK COMPONENT ECONOMICALLY MEANINGFUL?
    • CONCLUSION
    • ENDNOTES
    • REFERENCES
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  • PDF (Subscribers Only)

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