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In: Economics

Just Rewrite This Paragraph So I can't find Palarsism (Typing Only) This has implications for retail...

Just Rewrite This Paragraph So I can't find Palarsism (Typing Only)

This has implications for retail investors when deciding which stock to invest in, since the bid-ask spread for the relevant trading day was higher for COA than for H&M. Assuming that they are uninformed, they would be taking a higher risk investing in COA since the trading costs are higher. Furthermore, one needs a bigger sample size to draw any further conclusions, but based on this case, it seems to be the case that the more liquid a stock is the smaller the bid-ask spread it has.

The implementation shortfall can be measured in both effective and realized cost. The effective cost is defined as the absolute value of the price paid minus the prevailing midpoint price at that time. The realized cost is defined in the same manner but where one uses the prevailing midpoint price 5 minutes after the trade was conducted.

We see that the realized costs and effective costs differs in both cases, where on average, the realized cost is less than the effective cost. One reason for this, is probably the direction of the trading taking place after the trade was conducted: the midpoint price was on average higher 5 minutes after the trade was conducted. This especially becomes clear in the H&M-case, where the realized cost was less than 0, i.e. the trade was on average profitable 5-minutes after the transaction.

Furthermore, by studying the graphs of the effective- and realized costs and also looking at the averages, one can conclude that these costs seem to be a bit higher for COA than for H&M. The main reason for this, is probably due to the fact that H&M is a more liquid stock, i.e. its spreads are tighter, having a lower implicit cost, thereby leading to a smaller difference between the prevailing price and the midpoint price.

Solutions

Expert Solution

So thishas implications for investor in retail when making a decision onwhich stock to invest in, since the bid-ask spread for the relevant trading day was lower for H&M than for COA . If we assume that they are uninformed, they would be taking a higher risk investing in COA since the costs involved in trading are higher. Furthermore, one needs a bigger sample size to draw any further conclusions, but looking on this case, it seems to be the case that the more liquid a stock is the smaller the bid-ask spread it has.

The implementation shortfall can be measured in both effective and realized cost. The effective cost is defined as the absolute value of the price paid minus the prevailing midpoint price at that time. The realized cost is defined in the same manner but where one uses the prevailing midpoint price 5 minutes after the trade was conducted.

We see that the realized costs and effective costs differs in both cases, where on average, the realized cost is less than the effective cost. One reason for this, is probably the direction of the trading taking place after the trade was conducted: the midpoint price was on average higher 5 minutes after the trade was conducted. This especially becomes clear in the H&M-case, where the realized cost was less than 0, i.e. the trade was on average profitable 5-minutes after the transaction.

Furthermore, by studying the graphs of the effective- and realized costs and also looking at the averages, one can conclude that these costs seem to be a bit higher for COA than for H&M. The main reason for this, is probably due to the fact that H&M is a more liquid stock, i.e. its spreads are tighter, having a lower implicit cost, thereby leading to a smaller difference between the prevailing price and the midpoint price.


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