Evaluation of the biases in execution cost estimation using trade and quote data

We use order data to assess the accuracy of execution cost estimation with trade and quote data. For our sample, estimates of the effective spread overstate actual execution costs by up to 17%. The biases result fromerrors in the inference of the trade direction and errors in the assignment of the benchmark quote. We find the accuracy of two popular trade direction algorithms improve marginally when trades are not lagged 5 seconds. Evaluation of the biases in execution cost measurement reveal the Ellis et al. (Journal of Financial and Quantitative Analysis (2000) 529) trade direction algorithm, combined with assigning benchmark quotes contemporaneous with trades, provides the least amount of bias. In general, biases are lower for relative effective spread estimates than effective spread estimates. r 2002 Elsevier Science B.V. All rights reserved. JEL classification: G10

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