Abstract
We use tick-by-tick data to study the dynamics of different components of implicit trading costs, including market impact cost, proportional cost, and fixed cost, over a decade. We model the proportional cost and the fixed cost as compensation for an affine structure of trading costs faced by the market maker. We find that the market impact cost remains stable over time, whereas the fixed cost and the proportional cost decrease significantly over time. We also find that the fixed cost is generally not equal to zero. Surprisingly, it goes negative lately.
Highlights
Over the last decade, trading cost analysis has been one of the biggest areas of investment for both the buy side and sell side of the equity industry, because trading cost can make the implementation of their trading strategies expensive
We model the proportional cost and the fixed cost as compensation for an affine structure of trading costs faced by the market maker
We find that the market impact cost remains stable over time, whereas the fixed cost and the proportional cost decrease significantly over time
Summary
Over the last decade, trading cost analysis has been one of the biggest areas of investment for both the buy side and sell side of the equity industry, because trading cost can make the implementation of their trading strategies expensive. None of the above papers study the relationship between price changes and changes in the inverses of order flows We model these two relationships as a result of compensating the market maker who incurs an affine structure of trading costs when processing order flows. We can solve the full equilibrium in this case Since institutional constraints such as discreteness and order process costs can lead to the existence of fixed and proportional costs, we study a case in which the market maker trades with an affine structure of costs in Subsection 2.2. Due to the non-trading region of the informed investor, we are unable to derive the full equilibrium and assume an exogenous price schedule
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