AQR: Investor Worries Over Trading Costs May Be Overblown

The total costs of equity trading just went down.

In a newpaper, AQR principals Andrea Frazzini, Ronen Israel, and Tobias Moskowitz argue that equity trading costs are actually lower than previous academic studies have shown. What sets their findings apart from previous studies is that the authors used execution data from $1.7 trillion worth of live trades made over 19 years by AQR Capital itself. The underlying data represented trades in 21 developed markets for nearly 10,000 stocks.

The AQR trio identified the price impact of multiple trade sizes and amounts; types of trades, such as buys or sells; the price when the trade was placed; and the execution price.

“The data offer a singular look into the real-time costs of an investor who resembles the theoretical ‘arbitrageur’ in asset pricing models,” wrote the authors of the paper, which was first published in late October of 2017. “The data also offer a unique look into how trading costs vary globally across trade type, size, and exchange,” they added.

[IIDeep Dive:Cliff Asness Knows Less than He Thought]

The study found, among other things, that the largest trades are the most expensive, and that the average cost of trading is lowest on the NYSE, compared to Nasdaq and international markets. Large-cap stocks were also found to have have less market impact than small-cap stocks, while short-selling was shown to cost more than selling long positions out of a portfolio.

“But the difference is not statistically significant,” the authors wrote. “Although a large literature discusses the additional costs associated with short-selling, conditional on actually shorting, we see no marked difference in trading costs between selling a long position versus selling short. If short selling is indeed costlier, it is likely to be from opportunity cost (i.e., not being able to short) or from lending fees for stocks on special.” The study, it should be noted, did not include shorting costs and revenues from lending – it just quantified the price impact.

The authors also looked at the drivers of trading costs, including market characteristics, the specific stocks traded, and the type of trade. They found that market structure has some role in price impact; for example, costs go down as the number of trading venues go up. The authors also found that trading costs go up in line with volatility and that these costs have declined over time in all markets.

To test their cost estimates, the authors used their models to forecast trading costs of live passive funds. “Examining Vanguard’s S&P 500 index fund and Blackrock’s iShares Russell 2000 ETF, our model predicts their costs accurately, suggesting that our cost estimates are in line with other large traders,” they wrote.

Frazzini, Israel, and Moskowitz argued that the new model could be helpful in determining the costs associated with a particular trading strategy, noting that they previously used it to “examine how various trading strategies based on asset pricing anomalies survive trading costs at different fund sizes,” as well as compute how large a fund needed to be for trading costs to fully erode a strategy’s expected return.