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Implementation Shortfall Costs -- what is the benchmark price?
I am quite confused about what price is supposed to be used as the benchmark price for implementation shortfall calculations -- is it the closing price of the stock on the day before the order was first instructed, or is it the price at which the order is instructed?
For example (I just made up this example):
Stock X had closing price of $20 at close on Monday (or maybe start of the day on Tuesday). On Tuesday, the manager instructed a limit order purchase of 100 shares at a price of $20.01 or less…..
So in this case which is the benchmark price -- $20 or $20.01?
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Quote from page 24 of book 6 of the CFA Curriculum:
"Implementation shortfall is defined as the difference between the money return on a notional or paper portfolio in which positions are established at the prevailing price when the decision to trade is made (known as the decision price, the arrival price, or the strike price) and the actual portfolio’s return."
(Institute 24)
Institute, CFA. CFA Institute Level III 2014 Volume 6 Portfolio: Execution, Evaluation and Attribution, and Global Investment Performance Standards. John Wiley & Sons P&T, 2013-07-12. VitalBook file.
But in the exercises, sometimes you have to calculate the four components of the implementation shortfall, all in the form of basis points. In this case, the denominator seems to be the number of shares in the original order times the 'benchmark' price. My question is -- what is this benchmark price? Is it the same as the decision price or not? There is a solved example in the CFAI books, but there they explicitly mention what they are taking as the benchmark price without saying anything about what it should be in general.
Decision price will be the closing price of the day you place your order. That's how i understood it.
Stock price closes @ $20.
Day 1: you place a limit order 100k shares @ 19.90
Price never falls below $20 and close at $21.00
Day 2: adjust your order to $22
filled 50k shares at $21.50
share prices went up and closed at $24
you cancelled the order.
benchmark price -> $20
decision price -> $21
execution price -> $21.50
cancellation price -> $24