A Distributed Method for Cooperative Transaction Cost Mitigation

TL;DR

This paper introduces a distributed optimization protocol enabling portfolio managers and firms to collaboratively reduce transaction costs without disclosing trade strategies, leading to significant cost savings.

Contribution

It presents a novel distributed convex optimization method for transaction cost mitigation that requires minimal communication and preserves trade confidentiality.

Findings

Few adjustment rounds achieve substantial cost savings.

Trades converge to optimal for the firm over multiple rounds.

Protocol maintains trade confidentiality and requires minimal communication.

Abstract

Funds at large portfolio management firms may consist of many portfolio managers (PMs), each managing a portion of the fund and optimizing a distinct objective. Although the PMs determine their trades independently, the trade lists may be netted and executed by the firm. These net trades may be sufficiently large to impact the market prices, so the PMs may realize prices on their trades that are different from the observed midpoint price of the assets before execution. These transaction costs generally reduce the returns of a portfolio over time. We propose a simple protocol, based on methods from distributed convex optimization, by which a firm can communicate estimated transaction costs to its PMs, and the PMs can potentially revise their trades to realize reduced transaction costs. This protocol does not require the PMs to disclose their method of determining trades to the firm or to each other, nor does it require the PMs to communicate their trade lists with each other. As the number of adjustment rounds grows, the trades converge to the ones that are optimal for the firm. As a practical matter we observe that even just a few rounds of adjustment lead to substantial savings for the firm and the PMs.