The implementation shortfall is a measure of the cost of trade implementation. It is a type of friction costs as it consists of the following four costs: explicit costs (broker and exchange costs, commissions, etc), delay costs, price impact costs (slippage), and opportunity costs associated with a specific trade. In formula form, implementation shortfall is the summation of explicit costs and implicit costs and is given by:
Implementation shortfall = explicit costs + implicit costs
Implementation shortfall = EC + R + DC + OC + PI
where: EC is explicit costs, R is realized profit or loss, DC is delay costs, OC is opportunity costs, and PI is price impact.
Realized profit/loss refers to the difference between execution price(s) and the decision price (usually the previous day’s close).
