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Testing the Markov property with ultra-high frequency financial data

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Author Info
Matos, Joao Amaro de
Fernandes, Marcelo

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Abstract

This paper develops a framework to nonparametrically test whether discretevalued irregularly-spaced financial transactions data follow a Markov process. For that purpose, we consider a specific optional sampling in which a continuous-time Markov process is observed only when it crosses some discrete level. This framework is convenient for it accommodates not only the irregular spacing of transactions data, but also price discreteness. Under such an observation rule, the current price duration is independent of previous price durations given the current price realization. A simple nonparametric test then follows by examining whether this conditional independence property holds. Finally, we investigate whether or not bid-ask spreads follow Markov processes using transactions data from the New York Stock Exchange. The motivation lies on the fact that asymmetric information models of market microstructures predict that the Markov property does not hold for the bid-ask spread. The results are mixed in the sense that the Markov assumption is rejected for three out of the five stocks we have analyzed.

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Publisher Info
Paper provided by Universidade Nova de Lisboa, Faculdade de Economia in its series FEUNL Working Paper Series with number wp462.

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Length: 25 pages
Date of creation: 2004
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Handle: RePEc:unl:unlfep:wp462

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Related research
Keywords: Bid-ask spread; nonparametric testing; price durations; Markov property; ultra-high frequency data;

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Find related papers by JEL classification:
C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Semiparametric and Nonparametric Methods
C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation and Testing
G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
G19 - Financial Economics - - General Financial Markets - - - Other

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    Other versions:
  2. Newey, Whitney K & West, Kenneth D, 1987. "A Simple, Positive Semi-definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix," Econometrica, Econometric Society, vol. 55(3), pages 703-08, May. [Downloadable!] (restricted)
    Other versions:
  3. Hasbrouck, Joel, 1991. " Measuring the Information Content of Stock Trades," Journal of Finance, American Finance Association, vol. 46(1), pages 179-207, March. [Downloadable!] (restricted)
  4. Joel L. Horowitz, 2003. "Bootstrap Methods for Markov Processes," Econometrica, Econometric Society, vol. 71(4), pages 1049-1082, 07. [Downloadable!] (restricted)
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  6. David Easley & Soeren Hvidkjaer & Maureen O'Hara, 2002. "Is Information Risk a Determinant of Asset Returns?," Journal of Finance, American Finance Association, vol. 57(5), pages 2185-2221, October. [Downloadable!] (restricted)
  7. Matos, Joao Amaro de & Rosario, Joao Sobral do, 2000. "The Equilibrium Dynamics for an Endogeneous Bid-Ask Spread in a Monopolistic financial Market," FEUNL Working Paper Series wp389, Universidade Nova de Lisboa, Faculdade de Economia. [Downloadable!]
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  10. Lawrence R. Glosten & Paul R. Milgrom, 1983. "Bid, Ask and Transaction Prices in a Specialist Market with Heterogeneously Informed Traders," Discussion Papers 570, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
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  11. Easley, David & O'Hara, Maureen, 1987. "Price, trade size, and information in securities markets," Journal of Financial Economics, Elsevier, vol. 19(1), pages 69-90, September. [Downloadable!] (restricted)
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  15. Easley, David & Kiefer, Nicholas M & O'Hara, Maureen, 1997. "One Day in the Life of a Very Common Stock," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 10(3), pages 805-35.
  16. GIOT, Pierre & ,, 1999. "Time transformations, intraday data and volatility models ," CORE Discussion Papers 1999044, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE). [Downloadable!]
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