VWAP - Larkin Topic Test

The curriculum is pretty vague regarding VWAP but Schweser notes the below:

Disadvantages of VWAP:

  • Not informative for trades that dominate trading volume (as described earlier).
  • Can be gamed by traders (as described earlier).
  • Does not evaluate delayed or unfilled orders.
  • Does not account for market movements or trade volume

Larkin Topic Test:

He states that VWAP attempts to measure the price benchmark for a trade with greater precision than other measures. Furthermore, Larkin asserts that VWAP is not affected by market impact implicit costs. And, he concludes, VWAP’s greatest contribution is that it provides an objective measure of missed trade opportunity costs.

That bolded statement is FALSE, based on the answer key.

How can VWAP not account for mkt movements/trade volume but also at the same time be affected by market impact implicit costs?

Has anyone given a thought on this? I saw another post in the forum asking about the same question. I’m also very confused by the explanation given in the answer key.

Same question here. Anyone?

I saw a sentence in the Kaplan "Implicit costs are measures using some benchmark, such as the midquote used to calculate the effective spared. An alternative is the VWAP. VWAP is a weighted average of execution prices during a day, where the weight applied is the proportion of the day’s trading volume. "

by very virtue that you could change the benchmark for VWAP - means you can adjust this benchmark to report the prices in your favor as a trading manager.

Thank you, cpk!

If so, can i say when VWAP is used as benchmark, it is affected by the market implicit cost?

Then, when will VWAP not be affected by the market implicit cost?

it is affected always by market implicit cost - but you can MOVE the benchmark in your favor as a manager - so it does not show the effect of the market implicit cost. e.g. if you made the benchmark price the last trading price in the day - and you sold / bought a very large volume at that price - your VWAP would be almost equal to that price you sold/purchased it at, so your market impact of that transaction will be almost 0… and you would be favorably looked at.

So are you saying vwap does not account for mkt movements or trade volume because manager can move the price benchmark?

This is from the text in Example 5 in the book

A broker with discretion on timing can also try to improve performance relative to a VWAP benchmark, because VWAP is partly determined at any point into the day. For example, if a buy order is received near the end of the day and the stock’s ask price exceeds the VWAP up to that point, the broker might try to move the order into the next day, when he will be benchmarked against a fresh VWAP.

In the solution to the same:

The CIO’s statement is correct. In contrast to the VWAP, which is partly deter- mined as the trading day progresses, the opening price is known with certainty at any point into the trading day, making it easier to game.

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Later in the white text immediately following :

To address the possibility of gaming VWAP, VWAP could be measured over mul- tiple days (spanning the time frame over which the order is executed), because traders would often be expected to try to execute trades within a day. However, the cost of measuring VWAP over a longer time frame is less precision in estimating trading costs.

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and in the page just preceding

Most traders measure implicit costs (i.e., costs excluding commissions) with ref- erence to some price benchmark or reference point. We have already mentioned one price benchmark: the time-of-trade midquote (quotation midpoint), which is used to calculate the effective spread. When such precise information is lacking, the price benchmark is sometimes taken to be the volume-weighted average price (VWAP). The VWAP of a security is the average price at which the security traded during the day, where each trade price is weighted by the fraction of the day’s volume associated with the trade. The VWAP is an appealing price benchmark because it allows the fund sponsor to identify when it transacted at a higher or lower price than the security’s average trade price during the day. For example, if a buy order for 500 shares was exe- cuted at €157.25 and the VWAP for the stock for the day was €156.00, the estimated implicit cost of the order would be 500 × (€157.25 – €156.00) = €625.15 If explicit costs were €25, the total estimated cost would be €650. Alternative price benchmarks include the opening and closing prices for a security, which use less information about prices and are less satisfactory. Although VWAP involves a data-intensive calculation, a number of vendors supply it.16 VWAP is less informative for trades that represent a large fraction of volume. In the extreme, if a single trading desk were responsible for all the buys in a security during a day, that desk’s average price would equal VWAP and thus appear to be good, however high the prices paid. Another limitation of VWAP (and of the effective spread) is that a broker with sufficient discretion can try to “game” this measure. (To game a cost measure is to take advantage of a weakness in the measure, so that the value of the measure may be misleading.) Furthermore, VWAP is partly determined at any point in the day; by using weights based on volume to that point in the day, a trader can estimate the final value of VWAP. The accuracy of such an estimate would tend to increase as the close of trading approaches. By comparing the current price to that estimate, the trader can judge the chances of doing better than VWAP.

==== Gaming of VWAP —> pretty important part of the LOSs if you have not read this before.

This is how I understand it:

​​​​​​ Does not account for market movements or trade volume

-if you look at VWAP alone, it will not give you any indication/insights on the volume of trades. For example: if Deutsche has a buy order for 1,000,000 shares of X that needs to be filled for the whole day, and at the end of the day total volume traded for X is 2,000,000 shares - Deutsche would have accounted for 50% of the total volume traded and the executed price of Deutsche would have been more or less the VWAP for the day, since Deutsche accounted for majority of the buying volume. Looking at the VWAP alone won’t give you such information (which is why it does not account for market movements or trade volume). You would have to refer to other information such as top buyers and sellers, time and sales, or total volume traded to truly evaluate how much Deutsche impacted the VWAP.

Also, if you were a fund manager evaluating Deutsche’s execution, it would seem as if he had a good execution (close to VWAP - if your benchmark was VWAP), if you only evaluated it based on executed price vs. stocks VWAP for the day.

Furthermore, Larkin asserts that VWAP is not affected by market impact implicit costs.

-this is false because, as stated above, since Deutsche accounted for 50% of the total volume traded, then his trades would have had the most market impact on the price. You can also think of implicit costs as: if Deutsche buys up a huge number of shares at the offer price, then the impact of that buy up would have increased the VWAP for the day (hence, affecting the VWAP)

>> Furthermore, VWAP is partly determined at any point in the day; by using weights based on volume to that point in the day, a trader can estimate the final value of VWAP.

The curriculum wording is a bit poor, especially the “partly determined” wording in my opinion. How much is partly? After reading it many times, i too agree VWAP can be moved. Thank you.

Thanks all for the help! More clear now!