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Disentangling Sources of High Frequency Market Microstructure Noise

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  • Simon Clinet
  • Yoann Potiron

Abstract

Employing tick-by-tick maximum likelihood estimation on several leading models from the financial economics literature, we find that the market microstructure noise is mostly explained by a linear model where the trade direction, that is, whether the trade is buyer or seller initiated, is multiplied by the dynamic quoted bid-ask spread. Although reasonably stable intraday, this model manifests variability across days and stocks. Among different observable high frequency financial characteristics of the underlying stocks, this variability is best explained by the tick-to-spread ratio, implying that discreteness is the first residual source of noise. We determine the bid-ask bounce effect as the next source of noise.

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  • Simon Clinet & Yoann Potiron, 2021. "Disentangling Sources of High Frequency Market Microstructure Noise," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 39(1), pages 18-39, January.
    • Handle: RePEc:taf:jnlbes:v:39:y:2021:i:1:p:18-39
    DOI: 10.1080/07350015.2019.1617158
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    Cited by:

    1. Yinfen Tang & Tao Su & Zhiyuan Zhang, 2022. "Distribution-free specification test for volatility function based on high-frequency data with microstructure noise," Metrika: International Journal for Theoretical and Applied Statistics, Springer, vol. 85(8), pages 977-1022, November.

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