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In this paper we develop a measure of liquidity, price impact, which quantifies the change in a firm's stock price associated with its observed net trading volume. For a large set of institutional trades we compare out-of-sample, characteristic-based estimates of price impact to actual price impacts. Predictive predetermined firm characteristics, chosen to proxy for the severity of adverse selection in the equity market, the non-information-based costs of making a market in the stock, and the extent of shareholder heterogeneity, include relative size, historical relative trading volume, institutional holdings, and the inverse of the stock price. We find numerous aspects of trade execution which are significantly related to the price impact forecast error in economically plausible ways: For example, the predicted price impact overestimates the actual price impact for very large trades, for trades executed in a more patient manner, and for trades where the institution pays higher commissions.Liquidity, Price Impact, Transactions Costs

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This paper examines liquidity and how it affects investor behavior, focusing on the considerations of a mutual fund portfolio manager. US mutual funds are the largest investor in US commercial paper with 47%, and they hold 35% of US tax-exempt debt, 27% of US equities, and about 10% of US corporate, Treasury, and agency debt (Investment Company Institute, 2008). Total mutual fund holdings worldwide equaled $26 trillion at year-end 2007. An understanding of the liquidity considerations of a portfolio manager therefore provides important insights into the liquidity of many assets and asset classes.A portfolio manager seeks to optimize the performance of her portfolio relative to her performance benchmarks. In this pursuit, she is limited by both what she needs to attain and the ease with which she can attain it. This makes her sensitive to three dimensions of liquidity: price, timing, and quantity. Deviations from perfect liquidity in any of these dimensions impose shadow costs on the portfolio manager, making them key considerations in her portfolio decisions.We define an asset to be perfectly liquid if a portfolio manager can trade the quantity she desires when she desires at a price not worse than the uninformed expected value. A few examples serve to motivate the three dimensions of liquidity and their shadow costs. Quantity may be the most important consideration for passive portfolio managers, such as those who are bound by prospectus