Transaction Cost Analysis A-Z

Transaction Cost Analysis A-Z — November 2008

II. Transaction Cost Components and Drivers

variable for both explicit and implicit costs. He finds that both explicit and implicit costs fall as system activity increases. Figure 8 illustrates this relationship for total transaction costs.

Figure 6: Explicit transaction costs

Figure 8: Total transaction costs vs. market system turnover

Source: Munck (2005)

Figure 7: Implicit transaction costs

Source: Munck (2005)

Third, the composition of transaction costs can vary across trading venues. Figure 9, excerpted from Munck (2005), breaks down total transaction costs in 2004 for the European exchanges in his sample. Except on the OMX Helsinki market, explicit costs account for the lion’s share of transaction costs, with an average of approximately sixty basis points. This cost composition is unlike that in US trading venues, where implicit costs tend to be higher.

Source: Munck (2005)

Second, transaction costs vary from region to region and even within regions. Although they are falling, they remain economically significant, especially in emerging markets. According to Domowitz et al. (2001), over the third quarter of 2000, total transaction costs ranged from twenty-two basis points in the Netherlands to 184 basis points in Venezuela, with a cross-country mean of about sixty basis points. Boussema et al. (2001) also compare transaction costs in developed and emerging markets. In their sample of trades, explicit costs (including only brokerage commissions) average 0.15% in developed markets and 0.61% in emerging markets. This phenomenon is similar for implicit costs (market impact and delay costs): they are about 0.23% in developed markets and approximately 0.58% in emerging markets. Checking for a possible correlation between costs and the use of trading systems, Munck (2005) identifies market system turnover as a statistically significant explanatory

Figure 9: Composition of transaction costs

100

80

60

40

20

Share of total trading costs

0

Oslo

Frankfurt

London (I) OMX Copenhagen

Euronext (II)

OMX Helsinki

OMX Stockholm

Implicit trading costs Explicit trading costs Average

Source: Munck (2005)

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An EDHEC Risk and Asset Management Research Centre Publication