Testing the Markov Property With Ultra-High Frequency Financial Data
FEUNL Working Paper No. 462
25 Pages Posted: 22 Feb 2006
Date Written: 2004
This paper develops a framework to nonparametrically test whether discretevalued irregularly-spaced financial transactions data follow a Markov process. For that purpose, we consider a specific optional sampling in which a continuous-time Markov process is observed only when it crosses some discrete level. This framework is convenient for it accommodates not only the irregular spacing of transactions data, but also price discreteness. Under such an observation rule, the current price duration is independent of previous price durations given the current price realization. A simple nonparametric test then follows by examining whether this conditional independence property holds. Finally, we investigate whether or not bid-ask spreads follow Markov processes using transactions data from the New York Stock Exchange. The motivation lies on the fact that asymmetric information models of market microstructures predict that the Markov property does not hold for the bid-ask spread. The results are mixed in the sense that the Markov assumption is rejected for three out of the five stocks we have analyzed.
Keywords: Bid-ask spread, nonparametric testing, price durations, Markov property, ultra-high frequency data
JEL Classification: C14, C52, G10, G19
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