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

Listed author(s):
  • 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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File URL: http://gcoe.ier.hit-u.ac.jp/research/discussion/2008/pdf/gd11-200.pdf
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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
Handle: RePEc:hst:ghsdps:gd11-200
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  13. Bollerslev, Tim & Domowitz, Ian, 1993. " Trading Patterns and Prices in the Interbank Foreign Exchange Market," Journal of Finance, American Finance Association, vol. 48(4), pages 1421-1443, September.
  14. Owens, John & Steigerwald, Douglas G, 2009. "Noise Reduced Realized Volatility: A Kalman Filter Approach," University of California at Santa Barbara, Economics Working Paper Series qt4n80536m, Department of Economics, UC Santa Barbara.
  15. Ole E. Barndorff-Nielsen & Neil Shephard, 2001. "Non-Gaussian Ornstein-Uhlenbeck-based models and some of their uses in financial economics," Journal of the Royal Statistical Society Series B, Royal Statistical Society, vol. 63(2), pages 167-241.
  16. Masato Ubukata & Kosuke Oya, 2009. "Estimation and Testing for Dependence in Market Microstructure Noise," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 7(2), pages 106-151, Spring.
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