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Dynamic Equilibrium and Volatility in Financial Asset Markets

Listed author(s):
  • Yacine Ait-Sahalia

This paper develops and estimates a continuous-time model of a financial market where investors' trading strategies and the specialist's rule of price adjustments are the best response to each other. We examine how far modeling market microstructure in a purely rational framework can go in explaining alleged asset pricing `anomalies.' The model produces some major findings of the empirical literature: excess volatility of the market price compared to the asset's fundamental value, serially correlated volatility, contemporaneous volume-volatility correlation, and excess kurtosis of price changes. We implement a nonlinear filter to estimate the unobservable fundamental value, and avoid the discretization bias by computing the exact conditional moments of the price and volume processes over time intervals of any length.

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File URL: http://www.nber.org/papers/w5479.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5479.

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Date of creation: Mar 1996
Publication status: published as Journal of Econometrics, Vol. 84 (1998): 93-127.
Handle: RePEc:nbr:nberwo:5479
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  17. Milgrom, Paul & Stokey, Nancy, 1982. "Information, trade and common knowledge," Journal of Economic Theory, Elsevier, vol. 26(1), pages 17-27, February.
  18. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-738, August.
  19. Wang, Jiang, 1994. "A Model of Competitive Stock Trading Volume," Journal of Political Economy, University of Chicago Press, vol. 102(1), pages 127-168, February.
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  21. Glosten, Lawrence R. & Milgrom, Paul R., 1985. "Bid, ask and transaction prices in a specialist market with heterogeneously informed traders," Journal of Financial Economics, Elsevier, vol. 14(1), pages 71-100, March.
  22. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-1335, November.
  23. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-436, June.
  24. Gould, John P & Verrecchia, Robert E, 1985. "The Information Content of Specialist Pricing," Journal of Political Economy, University of Chicago Press, vol. 93(1), pages 66-83, February.
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  29. Poterba, James M. & Summers, Lawrence H., 1988. "Mean reversion in stock prices : Evidence and Implications," Journal of Financial Economics, Elsevier, vol. 22(1), pages 27-59, October.
  30. LeRoy, Stephen F & Porter, Richard D, 1981. "The Present-Value Relation: Tests Based on Implied Variance Bounds," Econometrica, Econometric Society, vol. 49(3), pages 555-574, May.
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