On the correlation structure of microstructure noise in theory and practice
- We argue for incorporating 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 as to improved volatility estimation methods.
Author: | Francis X. Diebold, Georg H. Strasser |
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URN: | urn:nbn:de:hebis:30-58883 |
Parent Title (German): | Center for Financial Studies (Frankfurt am Main): CFS working paper series ; No. 2008,32 |
Series (Serial Number): | CFS working paper series (2008, 32) |
Document Type: | Working Paper |
Language: | English |
Year of Completion: | 2008 |
Year of first Publication: | 2008 |
Publishing Institution: | Universitätsbibliothek Johann Christian Senckenberg |
Release Date: | 2008/10/21 |
Tag: | Financial econometrics; High-Frequency Data; Market Microstructure Theory; Realized Volatility |
GND Keyword: | Marktstruktur |
HeBIS-PPN: | 206950683 |
Institutes: | Wissenschaftliche Zentren und koordinierte Programme / Center for Financial Studies (CFS) |
Dewey Decimal Classification: | 3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft |
JEL-Classification: | C Mathematical and Quantitative Methods / C5 Econometric Modeling / C51 Model Construction and Estimation |
Licence (German): | Deutsches Urheberrecht |