Noisy Prices and Inference Regarding Returns

Abstract:     
Temporary deviations of trade prices from fundamental values impart bias to estimates of mean returns to individual securities, to differences in mean returns across portfolios, and to parameters estimated in return regressions. We consider a number of corrections, and show them to be effective under reasonable assumptions. In an application to CRSP monthly returns, the corrections indicate significant biases in uncorrected return premium estimates associated with an array of firm characteristics. The bias can be large in economic terms, e.g., equal to 50% or more of the corrected estimate for firm size and share price.

Number of Pages in PDF File: 89

Keywords: Microstructure Noise, Illiquidity, Asset Pricing, Return Premium

JEL Classification: G1, G2

Accepted Paper Series