Price Discovery and Market Microstructure Noise

Abstract

We show that the standard econometric framework typically yields inconsistent estimates of price discovery measures in the presence of richer market microstructure noise dynamics. We address this errors-in-variable issue using instrumental variables. We devise valid instruments for two alternative microstructure noise settings, and then establish the asymptotic behavior of the corresponding price discovery measures. Our empirical analysis reveals that market leadership conclusions depend heavily on whether we account or not for the market microstructure noise.

Keywords: high-frequency data, price discovery, instrumental variables, weak instruments, realized measures

JEL Classification: G15, G12, G32, C32, C58