Chapter 10 - Transaction Cost Research

Abstract

This chapter focuses on transaction cost research (TCR), which has been defined by the TABB Group as the amount of money spent to open a new position or to close an existing position. TCR can be defined as the movement of the stock price from the time of the investment decision to the expiration or completion of the order. TCR includes the measurement of transaction costs after the trade is executed (post-trade) as well as expected costs before the order is placed (pre-trade). The interest in transaction cost research is widely attributable to the increasing competition for lower transaction costs and regulatory pressure. Investment managers are being pushed to measure and manage transaction costs to increase investment returns, retain clients, attract new prospects, and satisfy regulators. When investment managers began to be judged by transaction costs, this began the push for algorithms and other advanced electronic execution tools. One universally known method of rating quality of execution is through achieving or exceeding the Volume-Weighted Average Price (VWAP). As investment managers increasingly desire to reduce implicit costs, broker-dealers have to fulfill this demand to retain client business. In the end, transaction cost research will be absorbed into the trading process and soon incorporated into stock charts, annual reports, and employee compensation plans.