On the Correlation Structure of Microstructure Noise: A Financial Economic Approach /
Diebold, Francis X.
On the Correlation Structure of Microstructure Noise: A Financial Economic Approach / Francis X. Diebold, Georg Strasser. - Cambridge, Mass. National Bureau of Economic Research 2010. - 1 online resource: illustrations (black and white); - NBER working paper series no. w16469 . - Working Paper Series (National Bureau of Economic Research) no. w16469. .
October 2010.
We introduce the financial economics of market microstructure into the financial econometrics of asset return volatility estimation. In particular, we use market microstructure theory to derive the cross-correlation function between latent returns and market microstructure noise, which feature prominently in the recent volatility literature. The cross-correlation at zero displacement is typically negative, and cross-correlations at nonzero displacements are positive and decay geometrically. If market makers are sufficiently risk averse, however, the cross-correlation pattern is inverted. Our results are useful for assessing the validity of the frequently-assumed independence of latent price and microstructure noise, for explaining observed cross-correlation patterns, for predicting as-yet undiscovered patterns, and for making informed conjectures regarding improved volatility estimation methods.
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Mode of access: World Wide Web.
On the Correlation Structure of Microstructure Noise: A Financial Economic Approach / Francis X. Diebold, Georg Strasser. - Cambridge, Mass. National Bureau of Economic Research 2010. - 1 online resource: illustrations (black and white); - NBER working paper series no. w16469 . - Working Paper Series (National Bureau of Economic Research) no. w16469. .
October 2010.
We introduce the financial economics of market microstructure into the financial econometrics of asset return volatility estimation. In particular, we use market microstructure theory to derive the cross-correlation function between latent returns and market microstructure noise, which feature prominently in the recent volatility literature. The cross-correlation at zero displacement is typically negative, and cross-correlations at nonzero displacements are positive and decay geometrically. If market makers are sufficiently risk averse, however, the cross-correlation pattern is inverted. Our results are useful for assessing the validity of the frequently-assumed independence of latent price and microstructure noise, for explaining observed cross-correlation patterns, for predicting as-yet undiscovered patterns, and for making informed conjectures regarding improved volatility estimation methods.
System requirements: Adobe [Acrobat] Reader required for PDF files.
Mode of access: World Wide Web.