Sampling Returns for Realized Variance Calculations: Tick Time or Transaction Time?
Econometric Reviews, Vol. 27, No. 1, pp. 230-253, 2008
28 Pages Posted: 6 Jun 2006 Last revised: 8 Jul 2008
This paper introduces a new model for transaction prices in the presence of market microstructure noise in order to study the properties of the price process on two different time scales, namely transaction time where prices are sampled with every transaction and tick time where prices are sampled with every price change. Both sampling schemes have been used in the literature on realized variance, but a formal investigation into their properties has been lacking. Our empirical and theoretical results indicate that the return dynamics in transaction time are very different from those in tick time and the choice of sampling scheme can therefore have an important impact on the properties of realized variance. For RV we find that tick time sampling is superior to transaction time sampling in terms of mean-squared-error, especially when the level of noise, number of ticks, or the arrival frequency of efficient price moves is low. Importantly, we show that while the microstructure noise may appear close to i.i.d. in transaction time, in tick time it is highly dependent. As a result, bias correction procedures that rely on the noise being independent, can fail in tick time and, if one insists, are better implemented in transaction time.
Keywords: realized variance, tick time, transaction time, pure jump process, market microstructure noise, optimal sampling
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