Abstract
Under the typical institutional trading arrangement a portfolio manager makes the trade decision and a trading desk executes the trade, with execution performance evaluated against a benchmark such as the volume weighted average price (VWAP). We show that this trading arrangement provides incentives to the trader that are at odds with the objectives of the portfolio manager. Specifically, traders maintain a relatively low ask quote during rising markets to expedite sell trades and a relatively high bid quote during falling markets to expedite buy trades. This process inhibits the security's natural tendency to rise (or fall) with the market. We provide empirical evidence of several properties of price-adjustment delays that are consistent with this model.
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