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Parametric Estimates of High Frequency Market Microstructure Noise as an Unsystematic Risk

Author

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  • Seifoddini , Jalal

    (Department of Financial Management, Science & Research Branch, Islamic Azad University)

  • Rahnamay Roodposhti , Fraydoon

    (Department of Financial Management, Science & Research Branch, Islamic Azad University)

  • Nikoomaram , Hashem

    (Department of Financial Management, Science & Research Branch, Islamic Azad University)

Abstract

Noise is essential for the existence of a liquid market, and if noise traders are not present in the market, the trade volume will drop severely and an important aspect of the market philosophy will be lost. However, these noise traders bring noise to the market, and the existence of noise in prices indicates a temporary deviation in prices from their fundamental values. In particular, high-frequency prices carry a significant amount of noise that is not eliminated by averaging. If the level of noise in stock prices remains high for a period of time, it can be identified as a risk factor because it indicates that the deviation from fundamental values has been sustained. In this paper, after estimating the microstructure noise in high-frequency prices through a modified parametric approach, using a portfolio switching method, we compared the performance of portfolios having a high level of noise with the performance of portfolios having a lower level of noise and concluded that the risk of the high noise level presents itself as a risk premium in the future return and that asset pricing models which capture the systematic risks cannot capture the noise risk in prices.

Suggested Citation

  • Seifoddini , Jalal & Rahnamay Roodposhti , Fraydoon & Nikoomaram , Hashem, 2015. "Parametric Estimates of High Frequency Market Microstructure Noise as an Unsystematic Risk," Journal of Money and Economy, Monetary and Banking Research Institute, Central Bank of the Islamic Republic of Iran, vol. 10(4), pages 29-50, October.
    • Handle: RePEc:mbr:jmonec:v:10:y:2015:i:4:p:29-50
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    References listed on IDEAS

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    More about this item

    Keywords

    Microstructure Noise; High Frequency Data; Quasi-maximum Likelihood Estimation (QMLE); Portfolio Switching;
    All these keywords.

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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