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Spread Risk Factor

Delo

Active Member
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Thread starter #1
How is the "Spread Risk Factor" of 0.005 calculated in below question ?
Maybe it is as stupid question, but I can't recall.
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David Harper CFA FRM

David Harper CFA FRM
Staff member
Subscriber
#3
I think the question is made difficult by semantics and units, specifically (i) it isn't obvious at first that that 0.00030 sample σ is in percentage, not dollar terms and (ii) the $0.00837 is not an expected transaction cost, it is the "worst expected transaction cost" or "99% confident transaction cost." The 99% liquidity cost (aka, worst expected transaction cost; Dowd's exogenous spread) is correctly specified as P*0.5*(µ+σ*2.33) = $59.75*0.5*(0.8368% + 0.030%*2.33) = $0.271. Then the "99% spread risk factor" is Malz' term for what we typically (also) refer to as the liquidity cost in percentage terms (LC%), so it is just the percentage equivalent, so the 0.005 = $0.271/$59.75 = 0.005 = 0.5%, or just just the "(worst) expected transaction cost" without the price: 0.5*(0.8368% + 0.030%*2.33) = 0.005. Thanks,
 
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