transaction-cost-modeling

To prevent unrealistic transaction costs from inflating small-cap backtest profits, you must enforce credible friction floors for slippage, commission, and bid-ask spreads based on market cap. Validating borrow APR and locating failure assumptions stops near-zero costs from fabricating returns.

Setting a constant slippage fraction causes backtest bugs because it fails to account for market impact and bid-ask spread volatility in small-cap universes. Applying realistic, spread-driven round-trip costs and side-specific friction floors prevents these modeling errors from misleading results.

To model short-side risk and locate failures in a backtest configuration, treat locate failure as a binary event where the trade does not happen, rather than standard slippage. Flagging borrow APR defaults that ignore hard-to-borrow risk ensures accurate short-side financing assumptions.

Realistic borrow APR and slippage floors for micro-cap backtesting depend on enforcing minimum credible friction per side, including spread-driven round-trip costs. Validating these parameters against hard-to-borrow risk and retail-size market impact prevents misleading small-cap backtest performance.

Using zero commission and PFOF assumptions when designing a backtest is flagged as a common modeling error. Treating payment for order flow as completely free creates unrealistic transaction-cost defaults, so enforcing explicit, auditable fee assumptions prevents inflated profits.

Market impact modeling for retail-size orders in mid-cap strategies is often flagged as a common backtest bug. Applying market-impact models to retail-size orders distorts results, so validating parameterization against the target universe ensures credible transaction-cost assumptions.