# Implementation shortfall: Adjusting for market movements

How does this work? what is the purpose? I am completely lost. According to schweser: E®=alpha+beta E(Rm) (is this the same as historical price regression?) over time, alpha=0 (why?)and the true implementation shortfall = implementation shortfall - beta E(Rm) ( why?) please help

It is just like beta. If you are a small cap fund manager and the small cap index is up 10% and you are up 12%, then after adjusting for beta you are up 2%. Market adjusted implementation shortfall is the same concept. Say you have a small cap stock that you believe is underpriced by 5% relative to the market. You make your decision to buy the stock and before you can the small cap market as a whole goes up 5% while your stock goes up 3%. BEFORE adjusting for the market (beta) it looks like you lost out on a 3% move, but really your potential alpha is even greater than it was before the overall market move (because YOUR small cap stock moved up less than the small cap index). I am doing a terrible job of explaining this. Does the above make any sense?

It’s measuring what the implementation shortfall is ignoring the stock’s sensitivity to the overall market (and assuming alpha is zero). Think of it like a “normalized” measure because it removes all the price behavior explained by the general market movements. You might want to do this to make a point. e.g. if the market-adjusted measure is negative while the non-adjusted measure positive, you might conclude that there’s not much implicit costs in your trading.

I think this should be clearly understood. But schweser does not explain it (if I remember correctly). Can anyone explain with some numbers and simple terms please ! TIA

Implementation shortfall with market adjustment IS (adjusted) = IS - beta (market return) - beta (market return) => is to remove the market movement effect. For example. If IS (w/o adjust) = 0.87% => doesn’t looks good at the first sight because the implicit cost + explicit cost is positive. But if during the trading period, the market rise 1%, your stock sensitivity (beta) is 1 Then… IS (w/ adjust) = 0.87%-1%(1) = -0.13%. Here, the shortfall is actually negative => looks good.

In a uprising market, your execution price should be higher. So if you pay higher execution price than the benchmark price, implicit cost only explain part of it, market mov’t is part of the reason. => need to remove the effect of market movement to know the real transaction cost.

singlesong80 where did you see this question or topic? i never came across it in the CFAI curriculum textbooks.

It is in VOL1 Schweser I am satisfied with B_C’s answer. Thanks

singlesong80 where did you see this question or topic? i never came across it in the CFAI curriculum textbooks.

Actually, conceptually I agree. However, quantitatively, I do not see why R§ and Short Fall % should have an addictive relationship.

singlesong80 Wrote: ------------------------------------------------------- > It is in VOL1 Schweser > > I am satisfied with B_C’s answer. Thanks It’s actually in Volume 5 of Schweser, in the first reading(s) regarding markets, algorithmic trading, etc. Pretty dull reading with a lot of rote memorization; I would hope (and kinda think) that there won’t be too many questions on this material.