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Volatility, Information Feedback and Market Microstructure Noise: A Tale of Two Regimes

54 Pages Posted: 23 Feb 2017 Last revised: 8 Mar 2017

Torben G. Andersen

Northwestern University - Kellogg School of Management; National Bureau of Economic Research (NBER); University of Aarhus - CREATES

Gökhan Cebiroglu

University of Vienna, Faculty of Business and Economics

Nikolaus Hautsch

University of Vienna - Department of Statistics and Operations Research; Center for Financial Studies (CFS)

Date Written: February 6, 2017

Abstract

We extend the classical “martingale-plus-noise” model for high-frequency prices by an error correction mechanism originating from prevailing mispricing. The speed of price reversal is a natural measure for informational efficiency. The strength of the price reversal relative to the signal-to-noise ratio determines the signs of the return serial correlation and the bias in standard realized variance estimates. We derive the model’s properties and locally estimate it based on mid-quote returns of the NASDAQ 100 constituents. There is evidence of mildly persistent local regimes of positive and negative serial correlation, arising from lagged feedback effects and sluggish price adjustments. The model performance is decidedly superior to existing stylized microstructure models. Finally, we document intraday periodicities in the speed of price reversion and noise-to-signal ratios.

Keywords: Volatility estimation; market microstructure noise; price reversal; momentum trading; contrarian trading

JEL Classification: C58, C32, G14

Suggested Citation

Andersen, Torben G. and Cebiroglu, Gökhan and Hautsch, Nikolaus, Volatility, Information Feedback and Market Microstructure Noise: A Tale of Two Regimes (February 6, 2017). Available at SSRN: https://ssrn.com/abstract=2921097

Torben Andersen

Northwestern University - Kellogg School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

University of Aarhus - CREATES ( email )

School of Economics and Management
Building 1322, Bartholins Alle 10
DK-8000 Aarhus C
Denmark

Gökhan Cebiroglu (Contact Author)

University of Vienna, Faculty of Business and Economics ( email )

Oskar-Morgenstern-Platz 1
Vienna, 1090
Austria
+43-1-4277-38682 (Phone)

Nikolaus Hautsch

University of Vienna - Department of Statistics and Operations Research ( email )

Oskar-Morgenstern-Platz 1
Vienna, A-1090
Austria

Center for Financial Studies (CFS) ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

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