Measures of implicit trading costs and buy-sell asymmetry

Gang Hu

Presented by: Archana Jain

Prior Literature
Institutional buys incur higher implicit trading costs than do sells (kraus and Stoll,1972; Chan and Lakonishok,
1993; Holthausen el al.,1987,1990; Keim and Madhavan, 1996)

Execution costs of large trades are affected by trade direction (Macey and OHara 1997) This asymmetry is sensitive to the underlying market condition (Chiyachantana et al. 2004)

Motivation/Contribution
Three categories of implicit trading cost measures : pre-trade, during trade and posttrade Widely documented buy-sell asymmetry is a result of specific characteristics of the pretrade measure Simple mechanical characteristics can have important implications of how empirical results are interpreted

Main Prediction/Hypothesis

Inclusion of all market participants

Typical institutional trading process

Three Measures

Side : 1 for buys and -1 for sells

Example: In the rising market: Prior close = $45, PE = $50 and Close = $55 Prior Close cost for Buy : 1{(50-45)/50}=+0.10, for sell -0.10 ; Buy > Sell Close cost for Buy : 1{(50-55)/50}= -0.10, for sell +0.10 ; Buy < Sell

Decomposition

Data
Data from Abel/Noser Corporation for the 4th quarter of 2001 Significant number of up and down trading days with generally bullish market trend Number of shares traded, dollar principal traded, commission paid by the institution and buy/sell Final sample: 332 institutions, 20.1 billion shares traded, $544.5 billion traded, 4686 different socks

Trading costs and decomposition

(Table 1)

Segmentation by market wide during trade market movement (Table 2)

Segmentation by stock-specific during trade market movement (Table 3)

Decomposition Regression of implicit trading costs (Table 4)

+ V

+ V

Multivariate regressions (table 5)

Conclusion
Buy- sell asymmetry in implicit institutional trading costs is a result of pre-trade measures Asymmetry is reversed when post-trade measures are used Pre/post trade measures are influenced by market movements, during trade measures are relatively neutral Pre-trade measure = market movement component + during-trade measure