Stochastic Volatility Models with Transaction Time Risk

CentER Discussion Paper No. 2004-24

28 Pages Posted: 24 Jun 2004

See all articles by Eric Renault

Eric Renault

University of North Carolina (UNC) at Chapel Hill - Department of Economics

Bas J. M. Werker

Tilburg University - Center for Economic Research (CentER)

Date Written: 2004

Abstract

We provide a structural approach to disentangle Granger versus instantaneous causality effects from transaction durations to price volatility. So far, in the literature, instantaneous causality effects have either been excluded or cannot be identified separately from Granger type causality effects. By giving explicit moment conditions for observed returns over (random) transaction duration intervals, we are able to identify the instantaneous causality effect, where news events drive simultaneously surprises in durations and surprises in volatilities. Based on ten large stocks traded at the NYSE, we conclude that instantaneous variance forecasts must be decreased by as much as one-third when not having seen the next transaction before its conditional median time. Also, taking into account the causality effects that we document, instantaneous variances are found to be much higher than indicated by standard volatility assessment procedures.

Keywords: Causality, continuous time models, transaction prices, transaction times, ultra-high frequency data

Suggested Citation

Renault, Eric and Werker, Bas J.M., Stochastic Volatility Models with Transaction Time Risk (2004). CentER Discussion Paper No. 2004-24, Available at SSRN: https://ssrn.com/abstract=557765 or http://dx.doi.org/10.2139/ssrn.557765

Eric Renault (Contact Author)

University of North Carolina (UNC) at Chapel Hill - Department of Economics ( email )

Chapel Hill, NC 27599
United States

Bas J.M. Werker

Tilburg University - Center for Economic Research (CentER) ( email )

Econometrics and Finance Group
5000 LE Tilburg
Netherlands

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