Opportunity Cost
Opportunity cost is the value of the next-best alternative you give up when you choose one use of a scarce resource — time, capital, balance-sheet, or a risk limit.
Definition
Opportunity cost is not the cash you spend. It is the foregone return of the best unused option. In a book it is the Sharpe you did not run, the unused DV01, or the credit line that cannot be reused once drawn. Accounting cost ignores it; economic decisions cannot.
Why it matters
Every position is a choice against something else. A ‘cheap’ bond that uses scarce repo or risk capital can be expensive once the alternative is priced. Desks that only look at P&L versus cash invent free lunches.
Case
Holding excess cash through a steep carry curve has an opportunity cost equal to the missed roll-down. The cash looks safe; the book under-earned versus the feasible T-bill barbell.
How to read it
Name the scarce constraint (capital, time, limit, inventory) and the next-best use. If you cannot name it, you are scoring a hobby, not an allocation.
Key papers
Landmark references with real publisher or arXiv links — not token-overlap noise.
- The Nature of the FirmCoase · 1937 · EconomicaOpportunity cost of organizing inside vs through markets.