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Forecasting market impact costs and identifying expensive trades

Author

Listed:
  • Jacob A. Bikker

    (Supervisory Policy Division, Strategy Department, De Nederlandsche Bank, Amsterdam, The Netherlands)

  • Laura Spierdijk

    (Faculty of Economics and Business, Department of Economics and Econometrics, University of Groningen, Groningen, The Netherlands)

  • Roy P. M. M. Hoevenaars

    (Department of Quantitative Economics, Maastricht University, Financial and Risk Policy Department, ABP, Schiphol, The Netherlands)

  • Pieter Jelle Van der Sluis

    (Department of Finance and Financial Sector Management, GTAA Fund, ABP Investments, Vrije Universiteit Amsterdam, Schiphol, The Netherlands)

Abstract

Often, a relatively small group of trades causes the major part of the trading costs on an investment portfolio. Consequently, reducing the trading costs of comparatively few expensive trades would already result in substantial savings on total trading costs. Since trading costs depend to some extent on steering variables, investors can try to lower trading costs by carefully controlling these factors. As a first step in this direction, this paper focuses on the identification of expensive trades before actual trading takes place. However, forecasting market impact costs appears notoriously difficult and traditional methods fail. Therefore, we propose two alternative methods to form expectations about future trading costs. Applied to the equity trades of the world's second largest pension fund, both methods succeed in filtering out a considerable number of trades with high trading costs and substantially outperform no-skill prediction methods. Copyright © 2008 John Wiley & Sons, Ltd.

Suggested Citation

  • Jacob A. Bikker & Laura Spierdijk & Roy P. M. M. Hoevenaars & Pieter Jelle Van der Sluis, 2008. "Forecasting market impact costs and identifying expensive trades," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 27(1), pages 21-39.
  • Handle: RePEc:jof:jforec:v:27:y:2008:i:1:p:21-39 DOI: 10.1002/for.1052
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    References listed on IDEAS

    as
    1. Chan, Louis K C & Lakonishok, Josef, 1997. " Institutional Equity Trading Costs: NYSE versus Nasdaq," Journal of Finance, American Finance Association, vol. 52(2), pages 713-735, June.
    2. Keim, Donald B & Madhaven, Ananth, 1996. "The Upstairs Market for Large-Block Transactions: Analysis and Measurement of Price Effects," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 1-36.
    3. Chan, Louis K C & Lakonishok, Josef, 1995. " The Behavior of Stock Prices around Institutional Trades," Journal of Finance, American Finance Association, vol. 50(4), pages 1147-1174, September.
    4. Bikker, Jacob A. & Spierdijk, Laura & van der Sluis, Pieter Jelle, 2007. "Market impact costs of institutional equity trades," Journal of International Money and Finance, Elsevier, vol. 26(6), pages 974-1000, October.
    5. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, March.
    6. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-838, May.
    7. Donald B. Keim & Ananth Madhavan, "undated". "The Cost of Institutional Equity Trades," Rodney L. White Center for Financial Research Working Papers 08-98, Wharton School Rodney L. White Center for Financial Research.
    8. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    9. repec:fth:pennfi:68 is not listed on IDEAS
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    Cited by:

    1. Jacob Bikker, 2013. "Is there an optimal pension fund size? A scale-economy analysis of administrative and investment costs," DNB Working Papers 376, Netherlands Central Bank, Research Department.
    2. repec:bla:jrinsu:v:84:y:2017:i:2:p:739-769 is not listed on IDEAS

    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods

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