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CFS Working Paper Series, Universität Frankfurt a. M. >
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http://hdl.handle.net/10419/43192
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| Title: | | On the correlation structure of microstructure noise in theory and practice  |
| Authors: | | Diebold, Francis X. Strasser, Georg H. |
| Issue Date: | | 2008 |
| Series/Report no.: | | CFS Working Paper 2008/32 |
| Abstract: | | 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. |
| Subjects: | | Realized Volatility Market Microstructure Theory High-Frequency Data Financial econometrics |
| JEL: | | G14 G20 D82 D83 C51 |
| Document Type: | | Working Paper |
| Appears in Collections: | | CFS Working Paper Series, Universität Frankfurt a. M.
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