JSM 2005 - Toronto

Abstract #303048

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Legend: = Applied Session, = Theme Session, = Presenter
Activity Number: 207
Type: Invited
Date/Time: Tuesday, August 9, 2005 : 8:30 AM to 10:20 AM
Sponsor: Journal of Business and Economic Statistics (JBES)
Abstract - #303048
Title: Realized Variance and Market Microstructure Noise
Author(s): Peter R. Hansen*+ and Asger Lunde
Companies: Stanford University and Aarhus School of Business
Address: Department of Economics, Stanford, CA, 94305-6072,
Keywords: Realized Variance ; Realized Volatility ; Integrated Variance ; Market Microstructure Noise Microstructure Noise ; Bias Correction ; High-Frequency Data
Abstract:

The realized variance (RV) is known to be biased because intraday returns are contaminated with market microstructure noise, particularly if intraday returns are sampled at high frequencies. In this situation, we examine a simple bias correction of the RV. The bias correction can reduce the mean squared error of the RV, and we show the bias corrected estimator can be utilized to uncover important characteristics of market microstructure noise. We characterize the bias under a general specification for the market microstructure noise, where the noise may be autocorrelated and need not be independent of the latent price process. Within this framework, we analyze a simple Newey-West type correction of the RV that yields an unbiased measure of volatility. An empirical analysis of the 30 stocks that comprise the Dow Jones Industrial Average reveals market microstructure noise is time-dependent and correlated with increments in the efficient price. These properties are found in both transaction and quotation data. Both characteristics have important implications for volatility estimation based on high-frequency data.

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Revised March 2005