Realized Correlation Tick-By-Tick
University of St. Gallen, Department of Economics, Discussion Paper No. 2007-02
32 Pages Posted: 19 Jan 2007
Date Written: January 2007
We propose the Heterogeneous Autoregressive (HAR) model for the estimation andprediction of realized correlations. We construct a realized correlation measure where both the volatilities and the covariances are computed from tick-by-tick data. As for the realized volatility, the presence of market microstructure can induce significant bias in standard realized covariance measure computed with artificially regularly spaced returns. Contrary to these standard approaches we analyse a simple and unbiased realized covariance estimator that does not resort to the construction of a regular grid, but directly and efficiently employs the raw tick-by-tick returns of the two series. Montecarlo simulations calibrated on realistic market microstructure conditions show that this simple tick-by-tick covariance possesses no bias and the smallest dispersion among the covariance estimators considered in the study. In an empirical analysis on S&P 500 and US bond data we find that realized correlations show significant regime changes in reaction to financial crises. Such regimes must be taken into account to get reliable estimates and forecasts.
Keywords: High frequency data, Realized Correlation, Market Microstructure, Bias correction, HAR, Regimes
JEL Classification: C13, C22, C51, C53
Suggested Citation: Suggested Citation