Skip to main content
Article thumbnail
Location of Repository

On the correlation structure of microstructure noise in theory and practice

By Francis X. Diebold and Georg H. Strasser

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

Topics: Marktstruktur, ddc:330
Year: 2008
OAI identifier: oai:publikationen.ub.uni-frankfurt.de:5914

Suggested articles


To submit an update or takedown request for this paper, please submit an Update/Correction/Removal Request.