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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.

Suggested Citation

  • Daisuke Nagakura & Toshiaki Watanabe, 2009. "A State Space Approach to Estimating the Integrated Variance and Microstructure Noise Component," Global COE Hi-Stat Discussion Paper Series gd09-055, Institute of Economic Research, Hitotsubashi University.
  • Handle: RePEc:hst:ghsdps:gd09-055
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    References listed on IDEAS

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    1. Nelson, Daniel B., 1990. "ARCH models as diffusion approximations," Journal of Econometrics, Elsevier, pages 7-38.
    2. Meddahi, N., 2001. "An Eigenfunction Approach for Volatility Modeling," Cahiers de recherche 2001-29, Centre interuniversitaire de recherche en ├ęconomie quantitative, CIREQ.
    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.
    4. Meddahi, N., 2001. "An Eigenfunction Approach for Volatility Modeling," Cahiers de recherche 2001-29, Centre interuniversitaire de recherche en ├ęconomie quantitative, CIREQ.
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    Cited by:

    1. Daisuke Nagakura & Toshiaki Watanabe, 2010. "A State Space Approach to Estimating the Integrated Variance under the Existence of Market Microstructure Noise," Global COE Hi-Stat Discussion Paper Series gd09-115, Institute of Economic Research, Hitotsubashi University.
    2. Ashish Arora & Lee G. Branstetter & Matej Drev, 2013. "Going Soft: How the Rise of Software-Based Innovation Led to the Decline of Japan's IT Industry and the Resurgence of Silicon Valley," The Review of Economics and Statistics, MIT Press, pages 757-775.

    More about this item

    Keywords

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

    JEL classification:

    • C0 - Mathematical and Quantitative Methods - - General
    • G0 - Financial Economics - - General

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