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Information Loss in Volatility Measurement with Flat Price Trading

  • Peter C.B.Phillips

    (Yale University, University of Auckland,University of York & Singapore Management University)

  • Jun Yu

    (Sim Kee Boon Institute for Financial Economics, Singapore Management University)

A model of financial asset price determination is proposed that incorporates flat trading features into an e¡é cient price process. The model involves the superposition of a Brownian semimartin- gale process for the efficient price and a Bernoulli process that determines the extent of flat price trading. The approach is related to sticky price modeling and the Calvo pricing mecha- nism in macroeconomic dynamics. A limit theory for the conventional realized volatility (RV) measure of integrated volatility is developed. The results show that RV is still consistent but has an inflated asymptotic variance that depends on the probability of flat trading. Estimated quarticity is similarly affected, so that both the feasible central limit theorem and the infer- ential framework suggested in Barndorff-Nielson and Shephard (2002) remain valid under flat price trading even though there is information loss due to flat trading e¡èects. The results are related to work by Jacod (1993) and Mykland and Zhang (2006) on realized volatility measures with random and intermittent sampling, and to ACD models for irregularly spaced transac- tions data. Extensions are given to include models with microstructure noise. Some simulation results are reported. Empirical evaluations with tick-by-tick data indicate that the effect of flat trading on the limit theory under microstructure noise is likely to be minor in most cases, thereby affirming the relevance of existing approaches.

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File URL: http://www.smu.edu.sg/institutes/skbife/downloads/CoFiE/Working%20Papers/Information%20Loss%20in%20Volatility%20Measurement%20with%20Flat%20Price%20Trading.pdf
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Paper provided by Sim Kee Boon Institute for Financial Economics in its series Working Papers with number CoFie-01-2008.

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Length: 45 Pages
Date of creation: May 2008
Date of revision:
Publication status: Published in SMU-SKBI CoFie Working Paper
Handle: RePEc:skb:wpaper:cofie-01-2008
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  1. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Paul Labys, 2001. "Modeling and Forecasting Realized Volatility," NBER Working Papers 8160, National Bureau of Economic Research, Inc.
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  9. N. Gregory Mankiw & Ricardo Reis, 2002. "Sticky Information Versus Sticky Prices: A Proposal To Replace The New Keynesian Phillips Curve," The Quarterly Journal of Economics, MIT Press, vol. 117(4), pages 1295-1328, November.
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