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The Price of Transaction Costs

The Price of Transaction Costs

Posted April 27, 2022 at 11:38 am


Capturing the systematic premia is the main aim of many quantitative traders. However, investors tend to overlook an important factor when backtesting. Trading costs are an essential part of every trade, and yet even when we consider them, we often only use an approximation. The recent article from Angana Jacob (SigTech) looks into how heavily trading costs affect the overall return of various strategies and analyzes multiple ways of implementing trading costs into the trading rules themselves.

Firstly, the author distinguishes between explicit and implicit components of the costs of a systematic trading strategy. The fees known in advance are categorized as the explicit components. On the other hand, the less visible and harder to estimate costs are categorized as implicit. Further, the author divides the implicit costs into three groups: Instant impact, Temporary impact, and Permanent impact. And because the implicit costs are often much greater than the explicit costs, the paper focuses mainly on instant impact costs, their influence on the strategy’s return, and possible ways to minimize them.

The article also debates the pros and cons of frequent rebalancing. If an investor rebalances their strategy too often, they might have the advantage of increased reactivity; however, the transaction costs may overpower the rebalancing premia. This is shown in an example of FX Short-term Value Strategy.

Additionally, Global Tactical Asset Allocation Strategy (GTAA), which is rebalanced daily, shows an even more extreme example of the price of transaction costs. The author improves the GTAA strategy by slowing the rebalancing by employing a threshold and increasing the lookback window in the return estimation for the mean-variance optimization.

Author: Angana Jacob

Title: How to control the hidden costs of systematic investing



Any backtest is only as good as the information put into it. And yet when it comes to trading costs it is often assumed that an approximation is accurate enough to account for real world trading frictions. In reality, the impact of trading costs can be similar in magnitude, or even outweigh, the systematic premia they aim to capture. Additionally, trading costs assume greater significance in a low-return environment as they effectively represent a greater proportion of potential return available.

Visit Quantpedia to read the full article:

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This material is from Quantpedia and is being posted with its permission. The views expressed in this material are solely those of the author and/or Quantpedia and Interactive Brokers is not endorsing or recommending any investment or trading discussed in the material. This material is not and should not be construed as an offer to buy or sell any security. It should not be construed as research or investment advice or a recommendation to buy, sell or hold any security or commodity. This material does not and is not intended to take into account the particular financial conditions, investment objectives or requirements of individual customers. Before acting on this material, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

Disclosure: Forex

There is a substantial risk of loss in foreign exchange trading. The settlement date of foreign exchange trades can vary due to time zone differences and bank holidays. When trading across foreign exchange markets, this may necessitate borrowing funds to settle foreign exchange trades. The interest rate on borrowed funds must be considered when computing the cost of trades across multiple markets.

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