The tremendous growth in equity trading over the past 20 years, fueled largely by the burgeoning assets of institutional investors such as mutual and pension funds, has created a renewed interest in the measurement and management of trading costs. Such costs - often called "execution costs" because they are associated with the execution of investment strategies - include commissions, bid/ask spreads, opportunity costs of waiting, and price impact from trading, and they can have a substantial impact on investment performance. This "implementation shortfall" is surprisingly large and underscores the importance of execution-cost control, particularly for institutional investors whose trades often comprise a large fraction of the average daily volume of many stocks. there has also been considerable interest from the regulatory perspective in defining "best" execution, especially in the wake of recent concerns about NASDAQ trading practices, the impact of tick size on trading costs, and the economic consequences of market fragmentation. In this project, we propose to explore the impact of transaction costs on optimal portfolio selection and trading behavior in two ways: (1) deriving best-execution trading strategies under specific functional forms for price dynamics and price-reaction functions; and (2) deriving the general equilibrium implications of transactions costs for asset prices and trading volume.
Lo, a., Mamaysky H. and J. Wang, 2001, "Asset Prices and Trading Volume under Fixed Transaction Costs," LFE Working Paper No. LFE-1042-02.
Lo, A. and J. Wang, 2000, "Trading Volume: Definitions, Data Analysis, and Implications of Portfolio Theory," Review of Financial Studies 13, 257-300.
Lo, A., MacKinlay, C. and J. Zhang, 2002, "Econometric Models of Limit-Order Executions'', Journal of Financial Economics 65, 31-71.
Bertsimas, D., Hummel, P. and A. Lo, 1999, "Optimal Control of Execution Costs for Portfolios,'' Computing in Science & Engineering, 1, 40-53.
Bertsimas, D. and A. Lo, 1998, "Optimal Control of Execution Costs'', Journal of Financial Markets 1, 1-50.
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