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Market Impact Cost

Market Impact Cost, along with the bid-ask ratio and volume measures, is a measure of the liquidity of an ETF. Less liquid securities are more thinly traded, and a single large trade can move their prices considerably. Morningstar's market impact measure is an estimate of the basis point change in an ETF's price caused by a $100,000 trade. A lower market impact implies the ETF is more liquid, but the actual size of price movements due to a single trade may vary considerably from this estimate depending on market activity.

The market impact cost for an ETF incorporates the information of the bid-ask spread, and even the depth of market order books, by measuring the volatility of market prices around the true portfolio value. Our market impact calculation standardizes that volatility to a basis point value from a $100,000 trade through the common assumption that trades in the ETF are sequentially independent, and return variance caused by the trade increases in linear proportion with the dollar size of each trade.

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