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Please use this identifier to cite or link to this item:
http://hdl.handle.net/2451/26358
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| Title: | When Is Noise Not Noise – A Microstructure Estimate of Realized Volatility |
| Authors: | Engle, Engle
Sun, Zheng |
| Issue Date: | 2007 |
| Series/Report no.: | FIN-07-047 |
| Abstract: | This paper studies the joint distribution of tick by tick returns and
durations between trades. Returns are decomposed into changes in full
information prices and microstructure noise, but the noise is modeled in
accordance with various models of market microstructure allowing rich
correlation structures both with the efficient price and over time. The
full information price has time varying volatility which depends upon
the arrival time of trades. The paper aims at three contributions:
First, the noise is modeled to allow asymmetric information, inventory
and order processing costs, and delayed quote setting. Second, the
response to the trade arrival times allows trade durations to be
informative on future volatility. Third, the estimated state space
models can act as a laboratory to examine various non-parametric
approaches to realized volatility estimation. Both simulated and actual
data can be compared across methods and the accuracy and efficiency
assessed as long as the parameteric model is viewed as a sufficiently
accurate representation. We apply the above model to 10 NYSE stock
transactions data series with varying transaction rates. It appears that
contemporaneous duration has little effect on the volatility per trade
after conditioning on the past, which means average per second
volatility is inversely related to the duration between trades.
Microstructure noise is found to be informative about the unobserved
efficient price, and the informational component explains 45% of the
total variation of the microstructure noise. |
| URI: | http://hdl.handle.net/2451/26358 |
| Appears in Collections: | Finance Working Papers
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