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Transaction Cost Analysis a-Z

Transaction Cost Analysis a-Z

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Published by smallake
An EDHEC Risk and Asset Management Research Centre Publication
An EDHEC Risk and Asset Management Research Centre Publication

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Categories:Types, Business/Law
Published by: smallake on Mar 21, 2013
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Transaction Cost Analysis A-Z
A Step towards Best Execution in the Post-MiFID Landscape
November 2008
An EDHEC Risk and Asset Management Research Centre Publication
Sponsored by
 
Foreword .................................................................................................................3Introduction ............................................................................................................5I. Transaction Cost Analysis as Part of the Investment Process ................9II. Transaction Cost Components and Drivers ..............................................13
1. Direct Explicit Transaction Costs ................................................................................................142. Indirect Explicit Transaction Costs .............................................................................................153. Implicit Transaction Costs .............................................................................................................194. Transaction Cost Magnitude ........................................................................................................235. Transaction Costs and Execution Methods .............................................................................25
III. Measuring Transaction Costs with Post-Trade Analysis ......................27
1. Benchmark Comparison .................................................................................................................282. Implementation Shortfall..............................................................................................................293. Common Pitfalls and Shortcomings in Transaction Cost Measurement ......................324. Measuring Transaction Costs under MiFID .............................................................................35
IV. Estimating Transaction Costs with Pre-Trade Analysis ........................39
1. Collection and Analysis of Pre-Trade Data..............................................................................402. Cost and Risk Estimation...............................................................................................................413. Optimisation and Efficient Trading Frontier ...........................................................................53
 V. Trading Performance Measurement ...........................................................57
1. Transaction Costs vs. Trading Performance.............................................................................582. Current State of the Industry and Practices ..........................................................................583. Regulatory Pressure: MiFID and its Best Execution Obligation .......................................64
 VI. A New Framework: the EBEX Indicators ..................................................67
1. General Presentation ......................................................................................................................682. Detailed Presentation of the Indicators ...................................................................................703. Illustration of the Framework ......................................................................................................77
Conclusion .............................................................................................................85References .............................................................................................................87About the EDHEC Risk and Asset Management Research Centre...........90About CACEIS ......................................................................................................94About NYSE Euronext .........................................................................................96About SunGard.....................................................................................................98
Table of Contents
Printed in France, November 2008. Copyright EDHEC 2008.The opinions expressed in this survey are those of the authors and do not necessarily reflect those of EDHEC BusinessSchool, Caceis, Euronext or Sungard.
 
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An EDHEC Risk and Asset Management Research Centre Publication
Transaction Cost Analysis A-Z
November 2008
After nearly ten years of debate, the finalimplementation of MiFID is radicallytransforming the European capital marketslandscape.New entrants such as Chi-X, Turquoise orEquiduct, new operating models developedby major brokerage firms or former centralexchanges, along with the developmentof advanced execution technologies suchas algorithmic trading, form what can becalled the MiFID revolution.Core to the change is the obligation of best execution, which is one of the pillarsthe regulator has imposed for a morecompetitive environment. But at the timethe European directives were drafted,there was no consensus on whatconstituted best execution; indeed, thereis still no consensus.Transaction cost analysis (TCA) lies at thevery heart of the best execution obligationand it is expected to become a tool that nointermediary and market participant canignore. The literature on TCA is abundantbut it remains difficult to find an overviewof TCA techniques that allows investmentfirms to develop a view on which of themany approaches could or should betaken.The objective of this report is to provide acomprehensive view of what TCA is, shedlight on the main underlying concepts anddocument the tools and techniques thathave been developed in the academic andprofessional worlds.This A-Z is the first step of a number of research initiatives that will make possiblea better understanding of execution riskand performance and ultimately providetools and technologies that lead to moreefficient trading systems.Far from being restricted to equity marketsalone, MiFID has so far prompted reactionmainly on infrastructure related to tradingin listed securities; more changes can beexpected in other markets. As such, oureffort will continue both in the fixedincome and the listed derivatives space inthe very near future.Finally, I would like to take the opportunityto thank the partners that have madepossible the creation of the ‘MiFID andBest Execution' research chair hosted bythe EDHEC Risk and Asset Managementresearch Centre. CACEIS, NYSE Euronextand SunGard have committed a significantamount of time as well as financial andtechnical support to the team, allowingus to offer material that, we hope, will beuseful to investment firms involved in theexecution process.
Foreword
Noël Amenc
Professor of FinanceDirector of the EDHEC Risk and Asset ManagementResearch Centre

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