Welcome to Scribd, the world's digital library. Read, publish, and share books and documents. See more
Download
Standard view
Full view
of .
Save to My Library
Look up keyword
Like this
2Activity
0 of .
Results for:
No results containing your search query
P. 1
Immediacy Cost-Opportunity Cost

Immediacy Cost-Opportunity Cost

Ratings: (0)|Views: 60 |Likes:
Published by Wayne H Wagner

More info:

Published by: Wayne H Wagner on Sep 04, 2009
Copyright:Attribution Non-commercial

Availability:

Read on Scribd mobile: iPhone, iPad and Android.
download as PDF, TXT or read online from Scribd
See more
See less

05/11/2014

pdf

text

original

 
_d-
--reffiffiffi #ffi
tu#ffiffiq.Wffi
#rffie-*$s
PARTNERS:
Wayne
H. WagnerEdward
C.
StoryLarry
J. Cuneo
SERVICES
PROVIDED TO
Institutional Investors
Investment Managers
Institutional Traders
Plan Sponsors
IMMEDIACYCOST
AND OPPORTUNIW
COST
COMMENTARY
#22
May
1989
The
basic
decisionfaced
bya
buy-side
traderis
between
taking
an
immediate
execution
or
waiting
for
a
later
execution,
perhapsunder more favorableterms.
By movingquickly,he
expects
to
incur
an Immediacy
Cost,
while he
exposes
himself
to
a
potentialOpportunity
Cost
if
he
waits.
How
that
tradeoffof
expectations
is
made
is the
heart
and the
art
of
trading.
Trading
requires
a
delicate balancing between
twoexpectationalcosts that
are faced
in
every
trading
decision:
n
An
ImmediacyCost
that
is
high
for
traders
who
demand immediate
execution.
and
is
expectationally
lower
for
less
urgent
traders
who
can
wait for
a
counterpartythat,hopeful-ly,
will
trade at
a
more
favorable
price.
*
An
Oooortunitv
Cost
that
increases
as
ex-
pected
time to completion
increases"
Oppor-
tunity
cost
is
incurredwhen
the information
motivatingthe
trade impactspricesbefore
thetrade
can
be
completed.
sons
forwantingtotrade
immediately:
they
knowsomething
that
will
soonmakeprices
move.
These
informationmotivated
tradershope to
pass
off
improperly
valued
stock on the
uninformed.The
dealer,
of
course, stands
in
the
first
row,
and
while his information
sources
are
usually
very
good,
he can
seldom
expect
to
be
the
first
to
know
anything.
Whatthe
dealer
must
do, then,is
to
protecthim-
self
by
[1]refining
his
information
sources,
espe-
cially
by
learning
about
his
clients
and
their
access
to
information,
[2]
turninghis
inventoryasquickly
as
possible,
and,
most
importantly,
[3]
operating
with
a
largeenough
spread
betweenbuy
price
and
sell
priceto
cover
both operating
costs and
losses
to
investors
who
possess
superior
information.
Immediac]f
{.ost',,
,.,,.!,::
Market liquidity
is
not
a
freegood
in
most
markets.
Somemarkets, e.g.
Trea-
sury
Bills,
have
high natural
liquidity
as
outside moti-
vated
buyers
and
sellers
interact
with
each
other.
Thus
investors
who
demand
im-
mediacy
usually
must
transactwith
a
market function-
ory, and
can
expect
to
pay
the
costs
of
having
that
service
provi-
ded
to
them.
A
trader
who
can
wait,
in
contrast,
displays
by
his
very
nonchalance
that
he isnot
motivated
byinformation.
Also,
a
trader
who
can
wait
greatly
enhances
theproba-
bility that
another
natural
investor
will
appear
to
claim theother
side
of
his trade
without invokins
Markets
that
are
not
naturally
liquid
can
be
made
liquid
artificially.
Specialists,dealers, andother
market functionaries
earn
a
living
by
provid-ing market
liquidityto
otherwise
illiquid
markets.
By
buying
and selling
fromtheir
own
inventory,
they
provideimmediate
liquidity
for
investors
for
whom
itwould
be
an
inconvenience(at
minimum)
to
wait
for
a
naturalcounterparty.
Of
course
the
dealer is
not
a
patsy
in
this activity;
he
knows
that
hiddenamong
the
convenience
motivated traders
are
traders
with
tansible
rea-
Figure
L
ImmediacyCost
:l:il*
i,tuiIlirrlr
**iil*i*rrJ.
$r:il*:
i.**
i:,rr:t*
i-4*.*:r-*.
{l*iifc}rl:i"r
t*d*:f-
i}-13
j4*1-:r#ii
 
Now
consideran investor
who
possesses
a
bit
of
knowledge
which
is
not
yet
fully
appreciated
by
the
rest
of
the
market.
His
expected
cost,
the
cost
of
not
transacting
soon enough,is steeply
upward sloping,
as
shownby the
uppermostcun'e
--labeled
I
as
in informa-
tion
--in
Figure
2.
We
call
this
curve
Oppor-
tunity
Cost.
Note thatthe
curve
rises
moresteeply
than the
ImmediacyCostcurve
falls
inFigure
1.
Compared
to
the
expected
Opportuni-
E
Cost,
the
Immediacy
Costpales
to
insignifi-
cance
for
the
information
motivatedinvestor.
Opportuhity
COSt]
::i::::::i]:]ii:i:i::]].]:1
Investors
who
are
motivated
by
less
time-sensitive
in-
formation,
(e.g.
contrarian
manag-
ers or
undiscovered
value
seekers)would
have
a
less
steeplysloping
Op-portunityCost.The
value
they
seek
is
not likelyto
be dis-
covered
in
a
very
short
period
of
the
services
of
a
dealer.
Thus
the
expected
cost
of
immediacy
slopesdownward
with
time,
as
shown
in Figure
1.
Note
that
these
arc
expectational
costs;
sometimes
an
expensive.tradecan
be
donequickly;
at
other
times
delay
will
not
serve
to
reduce
the cost
of
a
particular
trade.
As thetrader
approaches
themarket,
however,
he faces
an
Immediacy
Cost
that
slopes
downwardwith
expected
time
to execution.pected
trading
cost
is much
wider
and
further to
the
right.
Not
only
should
the
index
fund
be
unwilling
to
incur
Immediacy Costs,index fundmanagers
have
a
greatdeal more
flexibility
to
apply
to
their
trading.
Theycan
applytrading
techniques
whichmaytake
a
relativelylong time
to
find
the counterparty
and
completethe
trade.
The total
expected
trade
cost
for
the
slow-information
manager
lies
be-
tween
the
two
ex-
tremes.
The
appropriate
trading
techniques
differ
for
each
of
thesestyles
of
investment
man-
agement.
Infor-
mation
traders
Figure
3
Total
Trade
Costs
need
to
apply
trading
techniques
which
providevery
rapid
execution, such
as
market
orders
forsmallertrades andprincipaltrades
for
large
orders.
These
techniqueswillprobably
cost
more
in
Immediacy
Costs,
but
they
will
avoid
a
po-
tentially
largeropportunity
cost.
Slower-information
traders
have
more
time
and
more
flexibility.
They canafford
to
wait
for
better trading
situations.
They can,
for
example,
advertise
their
interest
in
hopes
of
drawing
outthenatural other
side.
Theycan also
affordto
wait
for
lower
cost
trading
alternatives
like
Cross-
ing Networks.
The
greatest
trading
advantage,
however
goes
tothe
index
fund,who
can
affordtowait
until
the
market
comes
to
him
on suitable
terms.Thinking
of
it
differently,he
lets the otherside
determine
the
timing
of
the
trade.
This
is
valuable
to
the
counterparty,comparable
to
the accommodatingdisposition
of
the
dealer.The
danger,
of
course,
is thatthe
index
fund
does
not
possess
the
infor-mation
and
quickturnaround
advantages
of
the
dealer.
While
he
should
be
able
to
reduce
his
trading
cost significantly,
it would
seem
to
requiresubstantialadditional
trading
skills
andpresence
for
the
index
fundto matchthe
dealer's
ability
to
make
money
in
the trading
process.
So
far,
we
haveshown
that trading
involves
bal-
ancing
the
decliningImmediacy Cost
against
therising Opportunity
Cost.
This
is
not
an easytask.
We
havealready
pointedout how
thesecosts
are
expectational
in
nature,
and
therefore
difficult to
assess.
Also, we
haveshown
thatthey
differfor
different
management
strategies.
In
addition,Figure
2
Opportunity
Cost
time.
We
have
labeled
them
S
for
slower.
The
lowest curve,labeledP
for
passive,
represents
the
indexfund,which
nevertrades
on
information
andfaces
a
minimal
OpportunityCost
due only
tothe
desire
to
remain
fully
invested.
ffi
Total
expectational
trade
cost
is
-.:-,
the
sum
of
the
Immediacy
Cost
j9:1'-
and
the
Opportunity
Cosl.
As
LfT"
shown
in
Figure
3,
these
lotal
uos['
expected
trade
costs
curveshave
a
"belly"
which
rePresents
an
area
of
minimum
cost.
For
in-
formation
motivatedtraders,
tlibt
area
of
cost
isfound
close
to
zerotime-to-com-
pletion
and
isshort
in
duration.
In
contrast,
the
indexfund'sarea
of
lowest
ex-
2

You're Reading a Free Preview

Download
/*********** DO NOT ALTER ANYTHING BELOW THIS LINE ! ************/ var s_code=s.t();if(s_code)document.write(s_code)//-->