Optimal Execution and Transaction Cost Models for Systematic Strategies

Transaction costs represent one of the most significant drags on systematic strategy performance. This paper presents a practical framework for modeling slippage, market impact, and commission structures to improve backtesting realism and live execution quality.

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The Cost of Ignoring Execution

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"Strategies that appear profitable in frictionless backtests often lose their edge entirely when realistic transaction costs are applied. The gap between paper and live Sharpe ratios is frequently 1.0-2.0 points."

A Unified Cost Framework

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1. Explicit costs: Commissions, exchange fees, and regulatory levies that are directly observable and contractually defined
2. Spread costs: The bid-ask spread as a function of liquidity, volatility, and time of day
3. Market impact: Temporary and permanent price displacement caused by order flow, modeled using square-root impact functions
4. Timing costs: Slippage between signal generation and execution, including delay and partial fill costs

Empirical Calibration

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Optimal Execution Algorithms

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