MARKET IMPACT MODEL APPLICATION FOR ASSESSING BROKER SERVICE QUALITY IN EQUITY MARKETS

Abstract

The paper applies the microstructural approach to analyze transaction costs accrued in the process of executing orders on financial exchanges. The extended classification of transaction costs on equity markets is presented. The set of challenges which arise in the analysis of a particular component of transaction costs – market impact – is outlined. It is proposed to apply R. Almgren’s market impact model to normalize observed costs. Normalized values exhibit a lower variance, and therefore, it requires a smaller sample of orders to choose the broker who provides the lowest transaction cost. As a result, the process of assessing broker service quality takes less time. Since, during the period of assessment, the investor has to use broker services to properly evaluate them, a faster process to weed out brokers who deliver higher transaction costs positively impacts investor’s financial results. As part of the larger challenge of reducing transaction costs of trading in financial equity markets, the specific case of market impact cost optimization on the basis of R. Almgren’s model was examined. The suggested methodology focuses on a specific component of market impact, which has lower variance, and could be used to weed out brokers with subpar levels of servicesfaster.