Volatility and Covariation of Financial Assets: A High-Frequency Analysis
AbstractUsing high frequency data for the price dynamics of equities we measure the impact that market microstructure noise has on estimates of the: (i) volatility of returns; and (ii) variance-covariance matrix of n. assets. We propose a Kalman-filter-based methodology that allows us to deconstruct price series into the true effcient price and the microstructure noise. This approach allows us to employ volatility estimators that achieve very low Root Mean Squared Errors (RMSEs) compared to other estimators that have been proposed to deal with market microstructure noise at high frequencies. Furthermore, this price series decomposition allows us to estimate the variance covariance matrix of n assets in a more efficient way than the methods so far proposed in the literature. We illustrate our results by calculating how microstructre noise affects portfolio decisions and calculations of the equity beta in a CAPM setting.
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Bibliographic InfoPaper provided by Birkbeck, Department of Economics, Mathematics & Statistics in its series Birkbeck Working Papers in Economics and Finance with number 0913.
Date of creation: Oct 2009
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Other versions of this item:
- Cartea, Álvaro & Karyampas, Dimitrios, 2011. "Volatility and covariation of financial assets: A high-frequency analysis," Journal of Banking & Finance, Elsevier, vol. 35(12), pages 3319-3334.
- Alvaro Cartea & Dimitrios Karyampas, 2009. "Volatility and covariation of financial assets: a high-frequency analysis," Business Economics Working Papers wb097609, Universidad Carlos III, Departamento de Economía de la Empresa.
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
- C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models &bull Diffusion Processes
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-11-21 (All new papers)
- NEP-ECM-2009-11-21 (Econometrics)
- NEP-MST-2009-11-21 (Market Microstructure)
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