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.

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Metadaten
Author:Francis X. Diebold, Georg H. Strasser
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:Universit├Ątsbibliothek 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):License LogoDeutsches Urheberrecht