The Financial Econometrics of Price Discovery and Predictability

This paper reviews recent econometric developments in the literature on price discovery and price predictability. For both areas, we discuss traditional approaches to econometric modeling, limitations to these approaches, and recent developments designed to overcome them. We also discuss the state-of-the-art and suggest future research. Three main conclusions are drawn. First, while many recent empirical applications in price discovery and price predictability are on the frontier of econometric methods, further developments are needed to increase relaxation of relevant assumptions and push the boundaries of applications. Second, future research in econometric modelling needs to combine/synthesize recent developments across multiple econometric issues rather than proceeding in a piecemeal manner, for instance, by integrating developments in the time series literature into panel-based frameworks. Third, recent econometric literature is generating findings that challenge long-held beliefs about apparent empirical regularities in price discovery and price predictability, thus presenting opportunities to develop relevant theory.