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Realized Variance and IID Market Microstructure Noise

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  • Asger Lunde
  • Peter Reinhard Hansen

Abstract

We analyze the properties of a bias-corrected realized variance (RV) in the presence of iid market microstructure noise. The bias correction is based on the first-order autocorrelation of intraday returns and we derive the optimal sampling frequency as defined by the mean squared error (MSE) criterion. The bias-corrected RV is benchmarked to the standard measure of RV and an empirical analysis shows that the former can reduce the MSE by 50%-90%. Our empirical analysis also shows that the iid noise assumption does not hold in practice. While this need not affect the RVs that are based on low-frequency intraday returns, it has important implications for those based on high-frequency returns

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File URL: http://repec.org/esNASM04/up.24351.1075581838.pdf
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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society 2004 North American Summer Meetings with number 526.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nasm04:526

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Keywords: Realized Variance; High-Frequency Data; Integrated Variance.;

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  1. Bollen, Bernard & Inder, Brett, 2002. "Estimating daily volatility in financial markets utilizing intraday data," Journal of Empirical Finance, Elsevier, vol. 9(5), pages 551-562, December.
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  10. Yacine Aït-Sahalia, 2005. "How Often to Sample a Continuous-Time Process in the Presence of Market Microstructure Noise," Review of Financial Studies, Society for Financial Studies, vol. 18(2), pages 351-416.
  11. French, Kenneth R. & Schwert, G. William & Stambaugh, Robert F., 1987. "Expected stock returns and volatility," Journal of Financial Economics, Elsevier, vol. 19(1), pages 3-29, September.
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