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Private Information and High-Frequency Stochastic Volatility

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  • Kelly David L.

    ()
    (University of Miami)

  • Steigerwald Douglas G

    ()
    (University of California, Santa Barbara)

Abstract

We study the effect of privately informed traders on measured high frequency price changes and trades in asset markets. We use a standard market microstructure framework where exogenous news is captured by signals that informed agents receive. We show that the entry and exit of informed traders following the arrival of news accounts for high-frequency serial correlation in squared price changes (stochastic volatility) and trades. Because the bid-ask spread of the market specialist tends to shrink as individuals trade and reveal their information, the model also accounts for the empirical observation that high-frequency serial correlation is more pronounced in trades than in squared price changes. A calibration test of the model shows that the features of the market microstructure, without serially correlated news, accounts qualitatively for the serial correlation in the data, but predicts less persistence than is present in the data.

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Article provided by De Gruyter in its journal Studies in Nonlinear Dynamics & Econometrics.

Volume (Year): 8 (2004)
Issue (Month): 1 (March)
Pages: 1-30

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Handle: RePEc:bpj:sndecm:v:8:y:2004:i:1:n:1

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  1. Clark, Peter K, 1973. "A Subordinated Stochastic Process Model with Finite Variance for Speculative Prices," Econometrica, Econometric Society, Econometric Society, vol. 41(1), pages 135-55, January.
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Cited by:
  1. Yoichi Otsubo & Bruce Mizrach, 2012. "The Market Microstructure of the European Climate Exchange," LSF Research Working Paper Series, Luxembourg School of Finance, University of Luxembourg 12-7, Luxembourg School of Finance, University of Luxembourg.
  2. Jonathan Wright, 2002. "Log-Periodogram Estimation Of Long Memory Volatility Dependencies With Conditionally Heavy Tailed Returns," Econometric Reviews, Taylor & Francis Journals, Taylor & Francis Journals, vol. 21(4), pages 397-417.
  3. Steigerwald, Doug & Vagnoni, Richard J., 2001. "Option Market Microstructure and Stochastic Volatility," University of California at Santa Barbara, Economics Working Paper Series qt1v2059c2, Department of Economics, UC Santa Barbara.
  4. Booth, G. Geoffrey & Gurun, Umit G., 2008. "Volatility clustering and the bid-ask spread: Exchange rate behavior in early Renaissance Florence," Journal of Empirical Finance, Elsevier, Elsevier, vol. 15(1), pages 131-144, January.

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