Noisy Prices and Inference Regarding Returns
89 Pages Posted: 29 Aug 2010 Last revised: 10 Oct 2011
Date Written: October 8, 2011
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.
Keywords: Microstructure Noise, Illiquidity, Asset Pricing, Return Premium
JEL Classification: G1, G2
Suggested Citation: Suggested Citation