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Dynamic Equilibrium and Volatility in Financial Asset Markets

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  • Yacine Ait-Sahalia

Abstract

This paper develops and estimates a continuous-time model of a financial market where investors' trading strategies and the specialist's rule of price adjustments are the best response to each other. We examine how far modeling market microstructure in a purely rational framework can go in explaining alleged asset pricing `anomalies.' The model produces some major findings of the empirical literature: excess volatility of the market price compared to the asset's fundamental value, serially correlated volatility, contemporaneous volume-volatility correlation, and excess kurtosis of price changes. We implement a nonlinear filter to estimate the unobservable fundamental value, and avoid the discretization bias by computing the exact conditional moments of the price and volume processes over time intervals of any length.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5479.

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Date of creation: Mar 1996
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Handle: RePEc:nbr:nberwo:5479

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  24. Tauchen, George E & Pitts, Mark, 1983. "The Price Variability-Volume Relationship on Speculative Markets," Econometrica, Econometric Society, vol. 51(2), pages 485-505, March.
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Cited by:
  1. J. Q. Smith & António Santos, 2005. "Second Order Filter Distribution Approximations for Financial Time Series with Extreme Outliers," GEMF Working Papers 2005-11, GEMF - Faculdade de Economia, Universidade de Coimbra.
  2. Frank Gerhard & Winfried Pohlmeier, 1998. "What a Difference a Day Makes: On the Common Market Microstructure of Trading Days," CoFE Discussion Paper 98-01, Center of Finance and Econometrics, University of Konstanz.

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