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Accounting for the Anomaly Zoo: a Trading Cost PerspectiveDISCUSSANT
Ingrid Tierens, Goldman Sachs
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ANOMALIES: FACT OR FICTION?
Decades of empirical finance research papers suggest anomalies exist
However,
• Data mining
• Post publication decay Nothing left?
• Implementation considerations
Anomalies prevalent in investment management
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FOCUS OF PAPER: IMPLEMENTATION CONSIDERATIONS
Two intertwined components
1) Implementation costs
2) Portfolio construction
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1) IMPLEMENTATION COSTS
Paper’s back-of-the-envelope calculation
[Net Return] ≈ [Gross Return] - 2 x [Each Leg’s Turnover] x [Bid-Ask Spread]
= 30 bps - 2 x 0.15 x 100 bps
= 0 bps per month
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Expected shortfall for Russell 2000 vs. S&P 500 (Goldman Sachs Shortfall Model estimates for a $500 mn portfolio traded over a full trading day)
5
TRADING COSTS THROUGH TIME
Sources: Russell, Standard & Poor’s, Goldman Sachs Securities Division data
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TRADING COST MODELING
.
Expected
Shortfall
Stock symbol
Start time
End time or participation rate
Volume over execution horizon
Bid-Ask Spread over execution
horizon
Volatility
Order size
= Trader decisions
Algo parent order
Buyside trading desk
Algo tranche
Tranches
Algo child orders
SOR
Exchanges Dark pools
SOR parent order
SOR venue orders
Venue executions
Portfolio rebalancing decision
Other execution strategy
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TRADING COSTS BY ORDER SIZE
Source: Goldman Sachs Securities Division, based on aggregated and non-attributed US orders from March 2013 to November 2013
Distribution of expected shortfall for S&P 500 and Russell 2000 constituents
Sources: Russell, Standard & Poor’s, Goldman Sachs Securities Division data as of September 25, 2019
bps
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2) PORTFOLIO CONSTRUCTION
Equal-weighted long-short quintile portfolios
However,
• Weights of expensive-to-trade names?
• Turnover?
[Net Return] ≈ [Gross Return] - 2 x [Each Leg’s Turnover] x [Bid-Ask Spread]
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ALTERNATIVE PORTFOLIO CONSTRUCTION APPROACHES
[Net Return] ≈ [Gross Return] - 2 x [Each Leg’s Turnover] x [Bid-Ask Spread]
• Value-weighted instead of equal-weighted
• Buy/hold spread thresholds
• Fully integrating implementation costs into portfolio construction
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FULLY INTEGRATED PORTFOLIO CONSTRUCTION
Stock Alphas
LegacyPortfolio
Portfolio Constraints
Shortfall Model
Optimizer
Risk Model
TradeList
OptimalPortfolio
User Input 3rd Party or Proprietary Data / Tools
User Output
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REAL WORLD EVIDENCE
Using proprietary trading data, e.g.
Ø “Trading Costs of Asset Pricing Anomalies”, Andrea Frazzini, Ronen Israel, and Tobias J. Moskowitz, 2015
Ø “Capacity of Smart Beta Strategies from a Transaction Cost Perspective”, Ronald Ratcliffe, Paolo Miranda and Andrew Ang, The Journal of Index Investing, Winter 2017
But other considerations to keep in mind
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SUGGESTIONS FOR FURTHER RESEARCH
Ø Investability considerations
Ø Shorting considerations
Ø Capacity considerations
May lead to additional insight into:
• What is driving anomalies?
• Which anomalies can survive?