Local Mispricing and Microstructural Noise: A Parametric Perspective

46 Pages Posted: 23 Feb 2017 Last revised: 29 Sep 2020

See all articles by Torben G. Andersen

Torben G. Andersen

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

Ilya Archakov

University of Vienna - Faculty of Business, Economics and Statistics

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); Vienna Graduate School of Finance (VGSF)

Date Written: July 24, 2020

Abstract

We extend the classic ''martingale-plus-noise'' model for high-frequency returns to accommodate an error correction mechanism and endogenous pricing errors. It is motivated by (i) novel empirical evidence documenting that microstructure noise exhibits frequently changing patterns of serial dependence and is interwoven with innovations to the efficient price; (ii) building a bridge between high-frequency econometrics and market microstructure models. We identify temporal pricing error corrections and noise endogeneity as complementary components driving high-frequency dynamics and inducing two separate regimes, characterized by the sign of the return serial correlation and an implied bias in realized variance estimates. We document frequent fluctuations between these regimes, which can be associated with price discovery in a setting with incomplete information and learning. The model links critical concepts from high-frequency statistics and market microstructure theory, suggesting new avenues for volatility estimation.

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

JEL Classification: C58, C32, G14

Suggested Citation

Andersen, Torben G. and Archakov, Ilya and Cebiroglu, Gökhan and Hautsch, Nikolaus, Local Mispricing and Microstructural Noise: A Parametric Perspective (July 24, 2020). Available at SSRN: https://ssrn.com/abstract=2921097 or http://dx.doi.org/10.2139/ssrn.2921097

Torben G. 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

Aarhus University - CREATES ( email )

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

Ilya Archakov

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

Vienna
Austria

Gökhan Cebiroglu

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

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

Nikolaus Hautsch (Contact Author)

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

Kolingasse 14
Vienna, A-1090
Austria

Center for Financial Studies (CFS) ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

Vienna Graduate School of Finance (VGSF) ( email )

Welthandelsplatz 1
Vienna, 1020
Austria

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