The Leverage Effect Puzzle: Disentangling Sources of Bias at High Frequency

52 Pages Posted: 15 Nov 2011

See all articles by Yacine Ait-Sahalia

Yacine Ait-Sahalia

Princeton University - Department of Economics; National Bureau of Economic Research (NBER)

Jianqing Fan

Princeton University - Bendheim Center for Finance

Yingying Li

Hong Kong University of Science & Technology (HKUST), Dept of ISOM and Dept of Finance; Hong Kong University of Science & Technology (HKUST) - Department of Information Systems, Business Statistics and Operations Management; Hong Kong University of Science & Technology (HKUST) - Department of Finance

Date Written: November 2011

Abstract

The leverage effect refers to the generally negative correlation between an asset return and its changes of volatility. A natural estimate consists in using the empirical correlation between the daily returns and the changes of daily volatility estimated from high-frequency data. The puzzle lies in the fact that such an intuitively natural estimate yields nearly zero correlation for most assets tested, despite the many economic reasons for expecting the estimated correlation to be negative. To better understand the sources of the puzzle, we analyze the different asymptotic biases that are involved in high frequency estimation of the leverage effect, including biases due to discretization errors, to smoothing errors in estimating spot volatilities, to estimation error, and to market microstructure noise. This decomposition enables us to propose novel bias correction methods for estimating the leverage effect.

Suggested Citation

Ait-Sahalia, Yacine and Fan, Jianqing and Li, Yingying, The Leverage Effect Puzzle: Disentangling Sources of Bias at High Frequency (November 2011). NBER Working Paper No. w17592. Available at SSRN: https://ssrn.com/abstract=1960139

Yacine Ait-Sahalia (Contact Author)

Princeton University - Department of Economics ( email )

Fisher Hall
Princeton, NJ 08544
United States
609-258-4015 (Phone)
609-258-5398 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jianqing Fan

Princeton University - Bendheim Center for Finance ( email )

26 Prospect Avenue
Princeton, NJ 08540
United States
609-258-7924 (Phone)
609-258-8551 (Fax)

HOME PAGE: http://orfe.princeton.edu/~jqfan/

Yingying Li

Hong Kong University of Science & Technology (HKUST), Dept of ISOM and Dept of Finance ( email )

Clear Water Bay, Kowloon
Hong Kong

Hong Kong University of Science & Technology (HKUST) - Department of Information Systems, Business Statistics and Operations Management ( email )

Clear Water Bay
Kowloon
Hong Kong

Hong Kong University of Science & Technology (HKUST) - Department of Finance ( email )

Clear Water Bay, Kowloon
Hong Kong

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