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A State Space Approach to Estimating the Integrated Variance under the Existence of Market Microstructure Noise

  • Daisuke Nagakura
  • Toshiaki Watanabe

We call the realized variance (RV), calculated with observed prices contaminated by (market) microstructure noises (MNs), the noise-contaminated RV (NCRV), and refer to the bias 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. 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 identifiable parameters. We illustrate how to estimate these parameters. We apply the proposed method to yen/dollar exchange rate data, where we find that most of the variation in NCRV is of the MN component. The proposed method also serves as a convenient way for estimating a general class of continuous-time stochastic volatility (SV) models under the existence of MN.

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Paper provided by Institute of Economic Research, Hitotsubashi University in its series Global COE Hi-Stat Discussion Paper Series with number gd11-200.

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Date of creation: Aug 2011
Date of revision:
Handle: RePEc:hst:ghsdps:gd11-200
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