Transaction Cost Analysis A-Z

Transaction Cost Analysis A-Z — November 2008

Introduction

the cost profile of any trading strategy through simultaneous estimation of cost and risk, develop optimisation techniques to derive an efficient trading frontier and devise the most appropriate strategy to meet the investor’s goal or comply with his preferences. We would like to take the opportunity to express our sincere thanks to Robert Kissell and Morton Glantz, who have made, amongst other things, a very significant contribution to a better understanding and approach to modeling pre-trade transaction cost and risk estimates. Our aim here is only to provide a synthetic overview of the question; we have therefore summarised their material, but a good understanding of the approach cannot be obtained without reading in detail the full methodology available in Kissel and Glantz's 2003 Optimal Trading Strategies . Section V is dedicated to trading performance evaluation. After having exposed how trading performance measurement differs from transaction cost measurement, we come back to the benchmark comparison approach, the most common practice in the industry, and we review its major shortcomings when it comes to measuring quality of execution. We then focus on the concept of best execution in general and see that although it is very fashionable, it is often misunderstood and does not mean the same thing to everyone. We conclude with the MiFID best execution obligation and show that the regulator has provided neither a clear definition nor a measurable objective to make up for the current absence of consensus in the industry.

Section VI gives us the opportunity to introduce a framework developed by the EDHEC Risk and Asset Management Research Centre team that makes it possible to address the crucial question of best execution evaluation for traders and investment managers. The model is explained in full and can be easily deployed and customised to financial institution’s specific needs.

8 An EDHEC Risk and Asset Management Research Centre Publication