You buy 500,000 shares through the day at a volume-weighted average of 50.20. The price before you started was 50.00 and the stock opens the next morning at 50.08. Split the execution shortfall into permanent and temporary impact and give the temporary component per share.

You buy 500,000 shares through the day at a volume-weighted average of 50.20. The price before you started was 50.00 and the stock opens the next morning at 50.08. Split the execution shortfall into permanent and temporary impact and give the temporary component per share.

Approach: Treat the overnight price as the level that survived the order, then split the shortfall into the part that persisted and the part that decayed away.

12 cents. The implementation shortfall is 50.20 - 50.00 = 20 cents per share, or $100,000 on 500,000 shares. Permanent impact is the part that survived overnight, 50.08 - 50.00 = 8 cents, so temporary impact is 20 - 8 = 12 cents. Permanent impact is the market's revision of fair value from the information your order carried and cannot be scheduled away. Temporary impact is the liquidity premium paid for trading faster than natural volume and shrinks if the order is stretched. A cost model that charges the whole 20 cents to the execution decision overstates the achievable saving by 8 cents.

Follow-up: If the stock opens the next morning at 49.98, what does a negative permanent impact estimate tell you about the measurement?

Key concepts: implementation shortfall, permanent impact, temporary impact, execution cost.