Transaction Cost Analysis (TCA) Library

Chapter
21
INTRODUCTION
This chapter provides the necessary insight into best-in-class practices used
to build and develop a customized suite of transaction cost analysis tools
using the Kissell Research TCA library. The transaction cost analysis
(TCA) library is available for different software packages including
MATLAB, Python, Excel, C/Cþþ, Java, .NET, and Hadoop. The package
is also available as a Generic COM Component and as a standalone EXE
file.
These functions are beneficial for portfolio management and TCA, and were
built using the formulas and mathematical framework presented in the pre-
ceding chapters. The most important reason for any firm to have a TCA
function library is that it allows firms to develop customized analytics
that can be easily combined with their own proprietary forecasting and
alpha generating models, and integrated into their own customized invest-
ment decision-making processes.
These TCA libraries help investors bridge the gap between portfolio man-
agement and trade execution. Investors no longer need to access broker-
dealer and third-party APIs and/or webservers. Most importantly, these
TCA tools provide investors with opportunity to incorporate their own pro-
prietary research and market views directly into their own quantitative
models, thus, eliminating the potential for information leakage, and ulti-
mately, leading to increased portfolio performance.
These library functions provide investors with the necessary suite of analyt-
ical functions to perform research related to global TCA, portfolio manage-
ment, investment research, portfolio and trade schedule optimization,
market microstructure research, and alpha capture analyses. It also provides
the foundation to develop a real-time algorithmic decision-making frame-
work based on the investment objective of the fund. These library functions
include a full collection of functions to perform various analyses including:
pre-trade analysis, post-trade analysis, cost curve derivation, liquidation

Algorithmic Trading Methods, Second Edition. https://doi.org/10.1016/B978-0-12-815630-8.00021-1

Copyright © 2021 Elsevier Inc. All rights reserved. 559
560 CHAPTER 21 Transaction Cost Analysis (TCA) Library

cost analysis, and single stock optimization, and multiperiod trade schedule
optimization.
The TCA library package can be downloaded from www.KissellResearch.
com.

TCA Library
KRG Models can be incorporated into Client Models, Analyses, and
Trading Systems. We provide TCA libraries for the following:
n MATLAB
n Python
n Excel Add-Ins
n C/Cþþ
n Java
n .NET
n Hadoop
n Generic COM Components
n Standalone EXE files
The TCA library is an essential trading tool for:
n Traders: Traders utilize the TCA library to develop customized trading
analytics and perform transaction cost analysis, pretrade cost estimation,
trade strategy evaluation, and posttrade measurement right on their own
desktop. These analytics assist traders develop appropriate algorithmic
decision-making rules that are consistent with the investment objective
of the fund. These libraries have been developed to so that funds can es-
timate market impact and trading costs, perform optimization, and deter-
mine which brokers and which algorithms perform best under different
types of market conditions. Since these analytics are developed by the
investors, they can independently rank brokers based on trading perfor-
mance and the value-added to their fund.
n Portfolio Managers: Portfolio managers utilize the TCA library to
develop alpha capture models and proprietary MI factor scores that
can be integrated into stock selection models, portfolio construction pro-
cess, as well as optimization. Managers use these tools to evaluate the
global trading cost environment, market impact, and its implications
on portfolio returns. These TCA library functions allow analysts to con-
structed long-term global cost indexes which can be used to back-test in-
vestment ideas and trading strategies, and perform portfolio
optimization. Portfolio managers also use the functions to develop
 Transaction Cost Analysis Using the TCA Library 561

advanced liquidation cost analyses that not only estimate the current cost
of the trade list but evaluate the expected trading costs that may arise un-
der extreme market conditions such as decreased liquidity, spiking vola-
tility, and adverse price momentum. These analytics ensure managers
have the necessary information on hand to perform analyses that will
enable funds to achieve their maximum level of returns.
n Compliance Officers: Compliance officers utilize the TCA library to
develop trade reports to ensure that brokers are meeting their best execu-
tion obligation to the fund. These reports monitor broker performing dur-
ing ensure brokers are adhering to properly specified trading rules and
guidelines, and if not, they provide investors with insight into how
best to revise trading rules and change algorithms given the real-time
market conditions. These reports can also serve as a report card of trade
execution quality for the broker after trading has completed, and to help
adhere to ever changing regulatory requirements.
n Quantitative Analysts: Quantitative analysts utilize the TCA library to
develop advanced proprietary financial models to assist in the stock se-
lection and investment decision process. Most importantly, these ana-
lyses can be run on the investors own desktop which preserves
information leakage that may be associated with accessing information
on a third-party website or API. These TCA research models can be in-
tegrated directly into proprietary optimizers, alpha stock selection
models, and trading systems to maximize opportunity to achieve their
trading and investment objections. These TCA libraries can help funds
manage trading costs through all phases of the investment process.
n Corporations: Corporations use these TCA library functions to evaluate
company stock price movement and trading behavior in their stock. Cor-
porations can develop analytics to help uncover possible high frequency
trading in their stock and its overall consequence on the long-term
growth potential of stock price. The library functions also provide the
necessary analytics needed to develop appropriate buy-back programs,
as well as to evaluate the buying/selling pressure on the price of the stock
due to outside market participants.

TRANSACTION COST ANALYSIS USING THE TCA

LIBRARY
Our TCA library provides the necessary information to develop and build
the following analytics and research products:
562 CHAPTER 21 Transaction Cost Analysis (TCA) Library

Pretrade Analysis: Develop pretrade models to estimate trading costs and

evaluate different trading strategies. This includes estimating market impact,
price appreciation, and timing risk. Traders can evaluate different trading
strategies and algorithms by incorporating their own market views and pro-
prietary alpha forecasts directly into these pretrade models. Traders use these
functions to perform single stock and portfolio multi-period trade schedule
optimization. This allows traders to select the most appropriate strategy to
balance the tradeoff between cost and risk, and based on the underlying in-
vestment objectives of the fund.
n Pretrade market impact parameters are available across global regions
(North America, Europe, Asia, Latin America, as well as Emerging
and Frontier Markets). See www.KissellResearch.com for information
on receiving the parameters.
Intraday Analyses: Develop real-time analytics to monitor transaction
costs. These models provide investors with point in time trading costs esti-
mates (for executed shares) and the projected trading costs that will result
from completing the order (for those shares that still need to be executed).
This is accomplished by incorporating market momentum and actual market
conditions (volume, volatility, and aggregated imbalances) directly into the
analysis. Intraday trade cost analysis will provide investors with the neces-
sary information to determine when and how to take advantage of market
conditions and favorable opportunities exist.
Posttrade Analysis: Perform posttrade analysis. Analysts use the TCA li-
brary to calculate costs and evaluate performance across various benchmarks
(Arrival, Open, VWAP, Close, T-1, and Tþ1) as well as compare actual
costs to a pretrade trading cost estimate calculated using the I-Star market
impact model. This allows funds to determine how well their brokers and al-
gorithms performed given actual market conditions. Investors can rank their
brokers and their algorithms to determine which brokers and algorithms are
adding value to the fund, and determine which algorithms and which brokers
may be underperforming expectations and causing the fund to incur unnec-
essary higher trading costs. Investors can compute the RPM of the trade and
determine which brokers are adding value to the trading process and which
brokers are causing funds to incur unnecessary trading costs. Customized
posttrade reports provide clients with the ability to sort, filter, and evaluate
different trading situations right on their own desktop.
 Transaction Cost Analysis Using the TCA Library 563

Back-Testing: Develop historical trading cost indexes to assist portfolio

managers back-test investment ideas. These indexes can estimate the cost
that investors would have incurred historically based on today’s market envi-
ronment, e.g., decimalization, electronic, algorithms, dark pools, internal
crossing, ATS, etc., rather than solely based on the market environment at
that point in time. Thus, providing a much more realistic trade cost and
back-testing environment. The back-testing index trading cost series can
be generated for a constant order size (% Adv), share quantity, or dollar
value. Additionally, the back-testing series can also be customized by mar-
ket, investment style, stock specific, or any investment objective. A custom-
ized back-testing environment can be integrated into portfolio construction,
liquidity analysis, optimization, and for stress-testing portfolios.
n See www.KissellResearch for a historical TCA database from 1993 to
present.
High Frequency Trading (HFT): High frequency traders can develop
customized models and calculate essential trading cost data using the TCA
library. This information can be directly integrated into their own proprietary
models (running on their own desktops) and into their own in-house trading
systems and applications. HFT firms can use the TCA library functions to
help uncover hidden trading patterns and price movement in the stock due
to investor buying and/or selling pressure. Ultimately, assisting investors
to uncover profiting trading opportunities.
Limit Order Modeling (LOM): The TCA library allows traders to develop
limit order models (LOM) to calculate the probability of executing at spec-
ified prices or better. This provides insight into whether an order should be
placed passively using limit orders (bids and asks) or traded aggressively us-
ing market orders. These analyses can be performed on the client’s own
desktop and can be customized for the investors actual trading needs. For
example, analytics can be developed using the TCA library to provide inves-
tors with a vector of orders including quantities prices, and corresponding
probability of achieving a fill. These can be calculated by using actual mar-
ket conditions and trading costs that are calculated based on the overall
buying and selling pressure of all market participants, and just as impor-
tantly, based on the investor’s total order size and unexecuted shares. This
includes the shares that have not yet been displayed to the market or dissem-
inated to a broker or broker system for execution. Thus, allowing the inves-
tor’s investment objectives to remain private. The TCA library helps
investors perform advanced LOM analysis.
564 CHAPTER 21 Transaction Cost Analysis (TCA) Library

Smart Order Routing (SOR): The TCA library allows traders to develop
smart order routing models (SOR) to improve overall trading performance
and reduce trading costs. These analytics assist investors evaluate expected
transaction costs across different trading venues based on market volumes,
price momentum, and turnover at each location. This provides investors
with the trading venue that will maximize the likelihood of achieving a fill
at the investor’s desired price or better. It also provides whether the order
should be routed to an exchange, to a displayed venue, or to a dark pool.
The TCA library helps investors perform advanced SOR analysis.
Cost Curves: Cost curves are used by portfolio managers as part of portfolio
construction and the investment decision process. Managers can utilize the
TCA library to develop analytics to compute the trading cost for a various
order sizes (such as %Adv, share quantity, dollar value) and by trading stra-
tegies such as VWAP, a specified percentage of volume (POV rate), or trade
time. These data can be incorporated into proprietary stock selection models,
quantitative screens, and optimization models. The TCA library allows these
estimates to be calculated on your own desktop and ensures the preservation
of valuable investment research.
Liquidation Cost Analysis: Portfolio managers and compliance officers can
utilize the TCA library to perform analysis on the portfolio to understand the
cost and risk of liquidating orders. The TCA library allows investors to
stress-testing portfolios under extreme market conditions, decreased
liquidity, spiking volatility, and failing company fiscal health. These ana-
lyses provide investors with insight into the potential consequences on the
portfolio resulting from dire market conditions and an unfavorable economy.
Investors can develop customized models and analytics to ensure adherence
to increasing and stringent regulatory liquidity requirements.
Optimization: Portfolio managers use the TCA libraries to develop custom-
ized optimization models and alpha forecasts. These can then be incorpo-
rated directly into proprietary investment decision processes. These
include portfolio optimization, stock selection, portfolio management, alpha
generation, and trade schedule optimization. It also provides investors with
ability to perform liquidation optimization to determine the most appropriate
orders and shares to sell from a portfolio in times of cash redemption needs.
Research: Analysts use the TCA library to develop customized and ongoing
research pertaining to global trading costsdby region and by country, and
research pertaining to market volumes, volatility, and correlation, and research
on the current market microstructure environment. In addition, analysts can
develop market research and commentary related to sector trading and invest-
ment styles, portfolio risk management, macro-economic trends, etc. The
 Transaction Cost Analysis Using the TCA Library 565

TCA library allows researchers to greatly enhanced thie productions using

real-time TCA functions.
Transition Management: Analysts can use the TCA library to develop a
portfolio management transition model to evaluate and analyze the best
way for a plan sponsor to transition from one portfolio (legacy) to a new
portfolio (target) given trading cost, risk, and tracking error constraints.
These analytics can be built to include risk analysis capabilities using a pro-
prietary risk model and with full trade schedule optimization capabilities.
These also include full broker and algorithm posttrade evaluation, and
insight into the most appropriate broker and/or algorithm to perform the
transition.
Corporate Buy-Back Model: Corporate analysts utilize the TCA library to
develop corporate buy-back models. This assists corporations (e.g., CEO,
CFO, Treasure, IRO, etc.) analyze how to best buy-back company stock
over a defined period (e.g., up to a year). These customized analysts help
evaluate tender prices and appropriate execution strategies considering
cash-flow, risk, and expected price appreciation. Analysts can also use these
customized models to evaluate similar companies and competitors.

List of TCA Functions

Below is a list of TCA functions contained in our TCA library (as of June
30, 2019) for different TCA categories. Please see table 21.1 and consult
www.KissellResearch.com for the most current updated list of TCA
functions.

Pretrade Analysis
n ¼ krgIstar()
n ¼ krgTempMI()
n ¼ krgPermMI()
n ¼ krgMI()
n ¼ krgTR()
n ¼ krgPA()
n ¼ krgLF()
n ¼ krgTotalTR()

Posttrade Analysis
n ¼ krgTCACost()
n ¼ krgZScore()
n ¼ krgValueAdd()
n ¼ krgRPM()
566 CHAPTER 21 Transaction Cost Analysis (TCA) Library

Table 21.1 Kissell Research TCA Library Functions.

Excel
C/ Generic Standalone Standalone add-
MATLAB Python CDD Java .NET Hadoop COM EXE APP in

Pre-Trade Analysis:
¼ krgIstar() U U U U U U U U U U
¼ krgTempMI() U U U U U U U U U U
¼ krgPermMI() U U U U U U U U U U
¼ krgMI() U U U U U U U U U U
¼ krgTR() U U U U U U U U U U
¼ krgPA() U U U U U U U U U U
¼ krgLF() U U U U U U U U U U
¼ krgTotalTR() U U U U U U U U U U

Post-Trade Analysis:
¼ krgTCACost() U U U U U U U U U U
¼ krgZScore() U U U U U U U U U U
¼ krgValueAdd() U U U U U U U U U U
¼ krgRPM() U U U U U U U U U U

Portfolio Management
¼ krgCostCurves() U U U U U U U U U
¼ krg2Mdl() U U U U U U U U U
¼ krgRiskAnalysis() U U U U U U U U U
¼ krgBackTest() U U U U U U U U U
¼ krgImbal() U U U U U U U U U U

Optimization
¼ krgSSOpt() U U U U U U U U U U
¼ krgTradeScheduleOpt() U U U U U U U U U
¼ krgQPOpt() U U U U U U U U U
¼ krgTCAPortOpt () U U U U U U U U U

Calculations
¼ krgLinearRegression() U U U U U U U U U
¼ krgLogisticRegression() U U U U U U U U U
¼ krgPCA() U U U U U U U U U U
¼ krgEigen() U U U U U U U U U U
¼ krgSVD() U U U U U U U U U U
¼ krgCov U U U U U U U U U U
¼ krgApproxCov() U U U U U U U U U U
¼ krgVolumeProfile() U U U U U U U U U U
¼ krgUniformProfile() U U U U U U U U U U
¼ krgInitPOV() U U U U U U U U U U
¼ krgInitParam() U U U U U U U U U U

Conversions
¼ krgPOV2Time U U U U U U U U U U
¼ krgTime2POV U U U U U U U U U U
 Transaction Cost Analysis Using the TCA Library 567

Portfolio Management
n ¼ krgCostCurves()
n ¼ krg2Mdl()
n ¼ krgRiskAnalysis()
n ¼ krgBackTest()
n ¼ krgImbal()

Optimization
n ¼ krgSSOpt()
n ¼ krgTradeScheduleOpt
n ¼ krgQPOpt()
n ¼ krgTCAPortOpt ()

Calculations
n ¼ krgLinearRegression()
n ¼ krgLogisticRegression()
n ¼ krgPCA()
n ¼ krgEigen()
n ¼ krgSVD()
n ¼ krgCov
n ¼ krgApproxCov()
n ¼ krgVolumeProfile()
n ¼ krgUniformProfile()
n ¼ krgInitPOV()
n ¼ krgInitParam()

Conversions
n ¼ krgPOV2Time
n ¼ krgTime2POV(Table 21.1)