VWAP and IS

CFA Level III
#1

Hi ,

Can someone please tell me when do we prefer VWAP to Implementation shortfall method.

I thought High urgency = Vwap

Large size = IS

#2

IS = trade FAST to minimize market price impact (Urgent and/or information based)

VWAP = trade with the flow to disguise your intentions

#3

I have same question: in 2014 AM Q10 Part C,

The question was Deternine the security for which each of the following trade execution is more approporate :

I- VAWP

2 - Implementation shortfall.

For implementation shortfall, why did they chose Torn over ZEPH? I thought Implementation shortfall is more suggested when the size of the trade is large relative to the average volume of the share?

Any idea?

#4

I think it’s the idea that no matter what, trading as a smaller % of total volume will yield more accurate performance numbers for any monitoring strategy. In that case look to the urgency (VWAP = low, I/S = high) to differentiate.

#5

When you use VWAP, u can manipulate the trading costs by waiting until you trade a favourable prices (below the VWAP for the day). There is no account for delay costs, or opportunity costs. You are under no urgency to trade.

When you use IS, you should trade quickly. As the costs incorporate your delay and the opportunity costs.

There is always a benefit from trading lower volumes and narrower spreads, however if we had to choose; VWAP is better for narrower spreads, and IS is more favourable when spread are wider.

#6

Also, if you had to trade large volumes, then you should be using a broker.

#7

High urgency: Implementation Shortfall, Broker, or Electronic communications networks

#8

So let’s do a summary for all three strategies. IS: use it when * the trade is urgent (information based trader who has High opportunity cost). * the market is trending up( buying order) or down (selling order) ( Think of up trend market, VWAP or TWAP ( both are based on participation where you split the trade into pieces) of course the opportunity cost is high to wait and trade later. * the size of the trade is high relative to avg daily volume. if the’re is a choice for broker go with broker . ---------- VWAP : use it when * trade size is low relative to average daily volume ( remember the gaming feature and how you can’t compare your trade with the market where the market volume is you basically) * non- trending market. Or trending down if it a buy and trending up for sale order. ( no opportunity cost. You can wait and trade slowly.) - low spread . ( the market is liquied and you can executes all the trade slowly with certainty) --------- TWAP use it when : * the stock is thinnly traded. Any different thoughts ?