The expected transaction cost including liquidity risk is calculated as:
Cost=21βΓMid-priceΓ(Mid-priceSpreadβ+ZΓΟ)
Given:
- Bid =
$199
- Ask =
$200
- Mid-price = 2200+199β=199.5
- Spread =
$200 - 199 = 1$
- Spread % = 199.51β=0.0050125
- Ο=0.0004
- Z for a 99% confidence level (one-tailed) is approximately
$2.326$.
Cost=21βΓ199.5Γ(0.0050125+2.326Γ0.0004)
Cost=99.75Γ(0.0050125+0.0009304)=99.75Γ0.0059429β0.5928
This value is closest to 0.5927.