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A State Space Approach to Estimating the Integrated Variance and Microstructure Noise Component

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  • Daisuke Nagakura
  • Toshiaki Watanabe

Abstract

We call the realized variance (RV) calculated with observed prices contaminated by microstructure noises (MNs) the noise-contaminated RV (NCRV) and refer to the component in the NCRV associated with the MNs as the MN component. This paper develops a state space method for estimating the integrated variance (IV) and MN component simultaneously. We represent the NCRV by a state space form and show that the state space form parameters are not identifiable; however, they can be expressed as functions of fewer identifiable parameters. We illustrate how to estimate these parameters. The proposed method is applied to yen/dollar exchange rate data.

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File URL: http://gcoe.ier.hit-u.ac.jp/research/discussion/2008/pdf/gd09-055.pdf
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Paper provided by Institute of Economic Research, Hitotsubashi University in its series Global COE Hi-Stat Discussion Paper Series with number gd09-055.

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Date of creation: Mar 2009
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Handle: RePEc:hst:ghsdps:gd09-055

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Keywords: Realized Variance; Integrated Variance; Microstructure Noise; State Space; Identification; Exchange Rate;

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  1. Nour Meddahi, 2001. "An Eigenfunction Approach for Volatility Modeling," CIRANO Working Papers 2001s-70, CIRANO.
  2. Nelson, Daniel B., 1990. "ARCH models as diffusion approximations," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 7-38.
  3. 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.
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