Tuesday, March 18, 2014

VWAP market impact = slippage

Suppose we have a 5000 IBM buy-order. VWAP is the benchmark chosen. Our goal is to predicted market impact. If the predicted MI is too large, then we should either be very careful, or decline the block order.

The predicted market impact is also the predicted slippage.

Let's put in some fake but concrete numbers. Suppose we estimate that submitting this block buy would raise today's eod_vwap by 100 bps. That means whatever today's eod_vwap happens to be, our execution_vwap will be higher by 1%.

If eod_vwap is $70 then our market impact is about $0.70
If eod_vwap is $75 then our market impact is about $0.75

I think we should inform our client that we can execute the block order at the benchmark eod_vwap + some spread. I would quote a spread like $1 given spot is $69 and I estimate today's eod_vwap to be $69.50.

Suppose client accepts and we execute the order and execution_vwap = $69.9. What's the realized market impact? We can only imagine "what if I had not done this big order". However, we can observe the benchmark eod_vwap = $69.10. We performed better than quoted. Slippage = execution_vwap - eod_vwap, so our slippage is smaller than our quote!

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