Implementation shortfall (IS) is defined as a measure of trading inefficiency– i.e., it measures the cost of trade implementation. For purchases (long positions), it is equal to the decision price or desired price (the price prevailing at the time a trader/ investor decides to trade- i.e., submits the order to the buy-side trading desk) minus the average execution price (actual price or transaction price or arrival price), including commissions, all related to the decision price.
Its advantages are summarized in the following:
- It helps evaluate the overall portfolio impact of implementation.
- It enables assessment of different components of implementation cost.
- It takes into account the tradeoff between price and immediacy.
