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A no-arbitrage approach to range-based estimation of return covariances and correlations

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  • Brandt, Michael W.
  • Diebold, Francis X.

Abstract

We extend the important idea of range-based volatility estimation to the multivariate case. In particular, we propose a range-based covariance estimator that is motivated by financial economic considerations (the absence of arbitrage), in addition to statistical considerations. We show that, unlike other univariate and multivariate volatility estimators, the range-based estimator is highly efficient yet robust to market microstructure noise arising from bid-ask bounce and asynchronous trading. Finally, we provide an empirical example illustrating the value of the high-frequency sample path information contained in the range-based estimates in a multivariate GARCH framework.

Suggested Citation

  • Brandt, Michael W. & Diebold, Francis X., 2004. "A no-arbitrage approach to range-based estimation of return covariances and correlations," CFS Working Paper Series 2004/07, Center for Financial Studies (CFS).
  • Handle: RePEc:zbw:cfswop:200407
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    References listed on IDEAS

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    1. Andersen T. G & Bollerslev T. & Diebold F. X & Labys P., 2001. "The Distribution of Realized Exchange Rate Volatility," Journal of the American Statistical Association, American Statistical Association, vol. 96, pages 42-55, March.
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    More about this item

    Keywords

    range-based estimation; volatility; covariance; correlation; absence of arbitrage; exchange rates; stock returns; bond returns; bid-ask bounce; asynchronous trading;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets

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