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Dynamic equilibrium and volatility in financial asset markets

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  • Ait-Sahalia, Yacine

Abstract

This paper develops and estimates a continuous-time model of a financial market where investors' trading strategies and the specialist's rule of price adjustments are the best response to each other. We examine how far modeling market microstructure in a purely rational framework can go in explaining alleged asset pricing `anomalies.' The model produces some major findings of the empirical literature: excess volatility of the market price compared to the asset's fundamental value, serially correlated volatility, contemporaneous volume-volatility correlation, and excess kurtosis of price changes. We implement a nonlinear filter to estimate the unobservable fundamental value, and avoid the discretization bias by computing the exact conditional moments of the price and volume processes over time intervals of any length.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Econometrics.

Volume (Year): 84 (1998)
Issue (Month): 1 (May)
Pages: 93-127

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Handle: RePEc:eee:econom:v:84:y:1998:i:1:p:93-127

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Web page: http://www.elsevier.com/locate/jeconom

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References

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Cited by:
  1. Smith, J.Q. & Santos, Antonio A.F., 2006. "Second-Order Filter Distribution Approximations for Financial Time Series With Extreme Outliers," Journal of Business & Economic Statistics, American Statistical Association, vol. 24, pages 329-337, July.
  2. Frank Gerhard & Dieter Hess & Winfried Pohlmeier, 1999. "What a Difference a Day Makes: On the Common Market Microstructure of Trading Days," Finance 9904006, EconWPA.

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