Opportunity Cost of Waiting
Thefinalcomponentoftradingcostsistheopportunitycost
ofwaiting.Aninvestorcouldreducethebid-askspreadand
priceimpactcostsoftradingbybreakinguplargeblocksinto
smallblocksandtradingoveralongerperiod.If,infact,there
wasnocosttowaiting,evenalargeinvestorcouldbreakup
tradesintosmalllotsandbuyorselllargequantitieswithout
affecting the price or the spread significantly. There is,
however,acosttowaiting.Inparticular,thepriceofanasset
thataninvestorwantstobuybecauseheorshebelievesthatit
isundervaluedmayrisewhiletheinvestorwaitstotrade,and
this,inturn,canleadtooneoftwoconsequences.Oneisthat
theinvestordoeseventuallybuy,butatamuchhigherprice,
reducingexpectedprofitsfrom theinvestment.Theotheris
that the price rises so much that the asset is no longer
undervaluedandtheinvestordoesnottradeatall.Asimilar
calculusapplieswhenaninvestorwantstosellanassetthat
he or she thinks is overvalued.
The cost of waiting will depend in great part on the
probabilitythattheinvestorassignsthatthepricewillrise(or
fall)whileheorshewaitstobuy(orsell).Wewouldargue
thatthisprobabilityshouldbeafunctionofwhytheinvestor
thinks the asset is under- or overvalued. In particular, the
following factors should affect this probability:
1.Isthevaluationassessmentbasedonprivateinformationor
isitbasedonpublicinformation?Privateinformationtendsto
haveashortshelflifeinfinancialmarkets,andtherisksof
sittingonprivateinformationaremuchgreaterthantherisks
of waiting when the valuation assessment is based on
informationthatisalreadypublic.Thus,thecostofwaitingis