Jumps in Equilibrium Prices and Market Microstructure Noise

44 Pages Posted: 19 Mar 2012

See all articles by Suzanne S. Lee

Suzanne S. Lee

Georgia Institute of Technology - Finance Area

Per A. Mykland

University of Chicago - Department of Statistics

Date Written: February 23, 2012

Abstract

Asset prices observed in financial markets combine equilibrium prices and market microstructure noise. In this paper, we study how to tell apart large shifts in equilibrium prices from noise using high frequency data. We propose a new nonparametric test which allows us to asymptotically remove the noise from observable price data and to discover jumps in fundamental asset values. We provide its asymptotic distribution to decide when such jumps occur. In finite samples, our test offers reasonable power for distinguishing between noise and jumps. Empirical evidence indicates that it is necessary to incorporate the presence of jumps in equilibrium prices.

Keywords: jumps, noise, nonparametric tests, high frequency data

JEL Classification: C12, C14, G14

Suggested Citation

Lee, Suzanne S. and Mykland, Per A., Jumps in Equilibrium Prices and Market Microstructure Noise (February 23, 2012). Journal of Econometrics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1693644

Suzanne S. Lee (Contact Author)

Georgia Institute of Technology - Finance Area ( email )

800 West Peachtree St.
Atlanta, GA 30308
United States

Per A. Mykland

University of Chicago - Department of Statistics ( email )

Chicago, IL 60637-1514
United States
773-702-8044 (Phone)

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