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A Compound Duration Model for High-Frequency Asset Returns

42 Pages Posted: 17 Aug 2014 Last revised: 8 Nov 2016

Eric M. Aldrich

University of California, Santa Cruz

Indra Heckenbach

University of California, Santa Cruz

Gregory Laughlin

Yale University

Date Written: October 13, 2016

Abstract

This paper builds a model of high-frequency equity returns by separately modeling the dynamics of trade-time returns and trade arrivals. Our main contributions are threefold. First, we characterize the distributional behavior of high-frequency asset returns both in ordinary clock time and in trade time. We show that when controlling for pre-scheduled market news events, trade-time returns of the near-month E-mini S&P 500 futures contract are well characterized by a Gaussian distribution at very fine time scales. Second, we develop a structured and parsimonious model of clock-time returns using a time-changed Brownian motion composed with a general, non-Lévy directing process. Particular cases of this model allow for leptokurtosis and volatility clustering in clock-time returns, even when trade-time returns are Gaussian. Finally, we highlight conditions for the directing process which are required in order to generate proper volatility dynamics while simultaneously matching the unconditional distribution of returns. In-sample fitting and out-of sample realized volatility forecasting demonstrate the strength of our model relative to leading candidates.

Keywords: High-frequency trading, US Equities, News arrival

JEL Classification: C22, C41, C58, G12, G14, G17

Suggested Citation

Aldrich, Eric M. and Heckenbach, Indra and Laughlin, Gregory, A Compound Duration Model for High-Frequency Asset Returns (October 13, 2016). Available at SSRN: https://ssrn.com/abstract=2481201 or http://dx.doi.org/10.2139/ssrn.2481201

Eric Mark Aldrich (Contact Author)

University of California, Santa Cruz ( email )

Santa Cruz, CA 95064
United States
831-459-4247 (Phone)

HOME PAGE: http://ealdrich.com

Indra Heckenbach

University of California, Santa Cruz ( email )

1156 High St
Santa Cruz, CA 95064
United States

Gregory Laughlin

Yale University ( email )

New Haven, CT 06520
United States
+1 (203) 436-9405 (Phone)

HOME PAGE: http://astronomy.yale.edu/people/gregory-laughlin

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