Arbeitspapier

On the correlation structure of microstructure noise in theory and practice

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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.

Language: Englisch

Bibliographic citation: Series: CFS Working Paper ; No. 2008/32

Classification: Wirtschaft
Information and Market Efficiency; Event Studies; Insider Trading
Financial Institutions and Services: General
Asymmetric and Private Information; Mechanism Design
Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
Model Construction and Estimation

Subject: Realized Volatility
Market Microstructure Theory
High-Frequency Data
Financial econometrics
Finanzmarkt
Ökonometrie
Mikrostrukturanalyse
Kapitalertrag
Volatilität
Theorie

Event: Geistige Schöpfung

(who): Diebold, Francis X.
Strasser, Georg H.

Event: Veröffentlichung

(who): Goethe University Frankfurt, Center for Financial Studies (CFS)

(where): Frankfurt a. M.

(when): 2008

Handle: http://hdl.handle.net/10419/43192

URN: urn:nbn:de:hebis:30-58883

Last update: 10.03.2025, 11:41 AM CET

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Object type

Arbeitspapier

Associated

Diebold, Francis X.
Strasser, Georg H.
Goethe University Frankfurt, Center for Financial Studies (CFS)

Time of origin

2008

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Model checks for the volatility under microstructure noise

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Structure correlation, Vol. 2

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International price discovery in the presence of microstructure noise

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Robust tests for white noise and cross-correlation

Arbeitspapier

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Asymptotic equivalence and sufficiency for volatility estimation under microstructure noise

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