transactions costs for publicly traded assets first and then
extend the analysis to cover nontraded assets.
Transactions Costs on Publicly Traded Assets
Therearesomeinvestorswhoundoubtedlyoperateunderthe
misconceptionthattheonlycostoftradingisthebrokerage
commissionthattheypaywhentheybuyorsellassets.While
thismightbetheonlycostthattheypayexplicitly,thereare
other costs that they incur in the course of trading that
generallydwarfthecommissioncost.Whentradinganyasset,
theyarethreeotheringredientsthatgointothetradingcosts.
Thefirstisthespreadbetweenthepriceatwhichyoucanbuy
anasset(thedealer’saskprice)andthepriceatwhich you
cansellthesameassetatthesamepointintime(thedealer’s
bidprice).Thesecondisthepriceimpactthataninvestorcan
create by trading on an asset, pushing theprice up when
buyingtheassetandpushingitdownwhileselling.Thethird
cost, which was first proposed by Jack Treynor in his article
1 ontransactionscosts,istheopportunitycostassociatedwith
waitingtotrade.Whilebeingapatienttradermayreducethe
first two componentsof trading cost, thewaiting cancost
profitsbothontradesthataremadeandintermsoftradesthat
wouldhavebeenprofitableifmadeinstantaneouslybutwhich
becameunprofitableasaresultofthewaiting.Itisthesumof
these costs in conjunction with thecommission costs that
makes up the trading cost on an asset.
Bid-Ask Spread
Thereisadifferencebetweenwhatabuyerwillpayandwhat
thesellerwillreceive,atthesamepointintimeforthesame
asset,inalmosteverytradedassetmarket.Thebid-askspread