When Do Low-Frequency Measures Really Measure Transaction Costs?

70 Pages Posted: 17 Jul 2019

See all articles by Mohammad R. Jahan-Parvar

Mohammad R. Jahan-Parvar

Board of Governors of the Federal Reserve System

Filip Zikes

Board of Governors of the Federal Reserve System

Date Written: 2019-07-08

Abstract

We compare popular measures of transaction costs based on daily data with their high-frequency data-based counterparts. We find that for U.S. equities and major foreign exchange rates, (i) the measures based on daily data are highly upward biased and imprecise; (ii) the bias is a function of volatility; and (iii) it is primarily volatility that drives the dynamics of these liquidity proxies both in the cross section as well as over time. We corroborate our results in carefully designed simulations and show that such distortions arise when the true transaction costs are small relative to volatility. Many financial assets exhibit this property, not only in the last two decades, but also in the previous century. We document that using low-frequency measures as liquidity proxies in standard asset pricing tests may produce sizable biases and spurious inferences about the pricing of aggregate volatility or liquidity risk.

Keywords: Liquidity Risk, Transaction Costs, Volatility

Suggested Citation

Jahan-Parvar, Mohammad R. and Zikes, Filip, When Do Low-Frequency Measures Really Measure Transaction Costs? (2019-07-08). FEDS Working Paper No. 2019-051. Available at SSRN: https://ssrn.com/abstract=3418948 or http://dx.doi.org/10.17016/FEDS.2019.051

Mohammad R. Jahan-Parvar (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

HOME PAGE: http://sites.google.com/site/mrjahan/

Filip Zikes

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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