What factors are trading costs systematically related to?

Trading costs are systematically related to stock liquidity characteristics, risk, and trade size because these factors influence the friction involved in executing trades in financial markets.

When stock liquidity is high, it means there are many buyers and sellers for a given stock, which typically leads to tighter bid-ask spreads and reduced trading costs. Conversely, illiquid stocks often have wider spreads, meaning higher costs when entering and exiting positions.

Risk is also a significant factor because assets associated with greater risk tend to have wider spreads and may incur higher trading costs due to the uncertainty of execution prices and potential slippage. For instance, during times of heightened market uncertainty or volatility, traders might demand higher premiums for executing trades in riskier assets.

Additionally, the size of the trade plays a role in the cost structure. Larger trades can exert more influence on the market price than smaller trades, especially in less liquid markets. Executing a large order without impacting the price might require breaking it down into smaller orders or using more sophisticated trading strategies, which can add to overall cost.

These dynamics make it clear that the relationship between trading costs and liquidity characteristics, risk, and trade size is fundamental to understanding the economics of trading in financial markets. Other factors, such as currency exchange rates or the