Implementation Shortfall in Transaction Cost Analysis: A Further Extension

Abstract

Transaction cost, defined as implementation shortfall that is originally proposed by Perold (1988), is an important element in portfolio performance measurement. There are several factors visible or fixed (such as commission and taxes) and variable (that are invisible or indirectly affect cost of investing) that affect implementation shortfall. If cost components are not carefully addressed, trader’s ability to pick right stocks alone cannot be enough to outperform the market portfolio. Wagner and Edwards (1993) extend the transaction cost by incorporating various factors such as price impact, timing cost, and opportunity cost in addition to commission that add up to total transaction costs which can significantly affect portfolio performance. Kissell (2006) has extended Wagner and Edwards (1993) by defining and classifying various components slightly different way and yet producing same transaction cost. We closely follow and extend Kissell (2006) to further classify opportunity costs. We show that all three models provide the same results and produce same Implementation Shortfall. Our further classification should give trader a better understanding of opportunity cost and source for controlling any or all of those costs while trading.