The Market Impact Of Passive Trading

The Market Impact Of Passive Trading by Michael Aked, Max Moroz, Research Affiliates

[buffett]

Executive Summary

The market impact, or implementation cost, of passive trading is composed of both explicit and implicit costs. The explicit cost is often referred to as implementation tracking error, defined as the observed difference between a fund’s performance and the index against which it is benchmarked. The implicit cost is the unobserved reduction in performance of the benchmark index as a result of trading activity. The relative contribution of each component is primarily determined by the implementation strategy. This article focuses on the implicit cost, which is harder to measure, and which is often the main component of an index fund’s implementation cost.

The authors use...