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Frequency of observation and the estimation of integrated volatility in deep and liquid financial markets

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Author Info
Alain Chaboud
Benjamin Chiquoine
Erik Hjalmarsson
Mico Loretan
Abstract

Using two newly available ultrahigh-frequency datasets, we investigate empirically how frequently one can sample certain foreign exchange and U.S. Treasury security returns without contaminating estimates of their integrated volatility with market microstructure noise. Using volatility signature plots and a recently-proposed formal decision rule to select the sampling frequency, we find that one can sample FX returns as frequently as once every 15 to 20 seconds without contaminating volatility estimates; bond returns may be sampled as frequently as once every 2 to 3 minutes on days without U.S. macroeconomic announcements, and as frequently as once every 40 seconds on announcement days. With a simple realized kernel estimator, the sampling frequencies can be increased to once every 2 to 5 seconds for FX returns and to about once every 30 to 40 seconds for bond returns. These sampling frequencies, especially in the case of FX returns, are much higher than those often recommended in the empirical literature on realized volatility in equity markets. We suggest that the generally superior depth and liquidity of trading in FX and government bond markets contributes importantly to this difference.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 905.

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Date of creation: 2007
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Keywords: Foreign exchange market Bond market

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  1. Bandi, Federico M. & Russell, Jeffrey R., 2006. "Separating microstructure noise from volatility," Journal of Financial Economics, Elsevier, vol. 79(3), pages 655-692, March. [Downloadable!] (restricted)
  2. Zhou, Bin, 1996. "High-Frequency Data and Volatility in Foreign-Exchange Rates," Journal of Business & Economic Statistics, American Statistical Association, vol. 14(1), pages 45-52, January.
  3. Andersen T. G & Bollerslev T. & Diebold F. X & Labys P., 2001. "The Distribution of Realized Exchange Rate Volatility," Journal of the American Statistical Association, American Statistical Association, vol. 96, pages 42-55, March. [Downloadable!] (restricted)
  4. Michael J. Fleming & Joshua V. Rosenberg, 2007. "How do treasury dealers manage their positions?," Staff Reports 299, Federal Reserve Bank of New York. [Downloadable!]
  5. Ole E. Barndorff-Nielsen & Neil Shephard, 2001. "Non-Gaussian Ornstein-Uhlenbeck-based models and some of their uses in financial economics," Journal Of The Royal Statistical Society Series B, Royal Statistical Society, vol. 63(2), pages 167-241. [Downloadable!] (restricted)
  6. Michael J. Fleming, 1997. "The round-the-clock market for U.S. Treasury securities," Economic Policy Review, Federal Reserve Bank of New York, issue Jul, pages 9-32. [Downloadable!]
  7. Ole E. Barndorff-Nielsen & Neil Shephard, 2002. "Estimating quadratic variation using realized variance," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 17(5), pages 457-477. [Downloadable!]
  8. Oomen, Roel C.A., 2006. "Properties of Realized Variance Under Alternative Sampling Schemes," Journal of Business & Economic Statistics, American Statistical Association, vol. 24, pages 219-237, April. [Downloadable!] (restricted)
  9. Asger Lunde & Peter Reinhard Hansen, 2004. "Realized Variance and IID Market Microstructure Noise," Econometric Society 2004 North American Summer Meetings 526, Econometric Society. [Downloadable!]
  10. Andersen, Torben G. & Bollerslev, Tim & Diebold, Francis X. & Vega, Clara, 2002. "Micro Effects of Macro Announcements: Real-Time Price Discovery in Foreign Exchange," Working Papers 02-16, Duke University, Department of Economics. [Downloadable!]
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  11. Zhang, Lan & Mykland, Per A. & Ait-Sahalia, Yacine, 2005. "A Tale of Two Time Scales: Determining Integrated Volatility With Noisy High-Frequency Data," Journal of the American Statistical Association, American Statistical Association, vol. 100, pages 1394-1411, December. [Downloadable!] (restricted)
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  12. Michael J. Fleming, 2007. "Who buys Treasury securities at auction?," Current Issues in Economics and Finance, Federal Reserve Bank of New York, issue Jan. [Downloadable!]
  13. Ole E. Barndorff-Nielsen & Shephard, 2002. "Econometric analysis of realized volatility and its use in estimating stochastic volatility models," Journal Of The Royal Statistical Society Series B, Royal Statistical Society, vol. 64(2), pages 253-280. [Downloadable!] (restricted)
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  14. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Paul Labys, 2003. "Modeling and Forecasting Realized Volatility," Econometrica, Econometric Society, vol. 71(2), pages 579-625, March. [Downloadable!] (restricted)
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  15. Ole E. Barndorff-Nielsen, 2004. "Power and Bipower Variation with Stochastic Volatility and Jumps," Journal of Financial Econometrics, Oxford University Press, vol. 2(1), pages 1-37. [Downloadable!] (restricted)
  16. Bruce Mizrach & Chris Neely, 2006. "The Transition to Electronic Trading in the Secondary Treasury Market," Departmental Working Papers 200603, Rutgers University, Department of Economics.
  17. Torben G. Andersen et al., 2003. "Micro Effects of Macro Announcements: Real-Time Price Discovery in Foreign Exchange," American Economic Review, American Economic Association, vol. 93(1), pages 38-62, March. [Downloadable!] (restricted)
  18. Laurent Calvet & Adlai Fisher, 2002. "Multifractality In Asset Returns: Theory And Evidence," The Review of Economics and Statistics, MIT Press, vol. 84(3), pages 381-406, August. [Downloadable!] (restricted)
  19. Neil Shephard & Ole E. Barndorff-Nielsen & Peter Reinhard Hansen & Asger Lunde, 2006. "Designing realised kernels to measure the ex-post variation of equity prices in the presence of noise," Economics Series Working Papers 264, University of Oxford, Department of Economics. [Downloadable!]
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  20. Hansen, Peter R. & Lunde, Asger, 2006. "Realized Variance and Market Microstructure Noise," Journal of Business & Economic Statistics, American Statistical Association, vol. 24, pages 127-161, April. [Downloadable!] (restricted)
  21. David W. Berger & Alain P. Chaboud & Sergey V. Chernenko & Edward Howorka & Jonathan H. Wright, 2006. "Order flow and exchange rate dynamics in electronic brokerage system data," International Finance Discussion Papers 830, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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