Disentangling Sources of High Frequency Market Microstructure Noise

Research output: Contribution to journalArticle

Abstract

Employing tick-by-tick maximum likelihood estimation on several leading models from the financial economics literature, we find that the market microstructure noise is mostly explained by a linear model where the trade direction, that is, whether the trade is buyer or seller initiated, is multiplied by the dynamic quoted bid-ask spread. Although reasonably stable intraday, this model manifests variability across days and stocks. Among different observable high frequency financial characteristics of the underlying stocks, this variability is best explained by the tick-to-spread ratio, implying that discreteness is the first residual source of noise. We determine the bid-ask bounce effect as the next source of noise.

Original languageEnglish
JournalJournal of Business and Economic Statistics
DOIs
Publication statusPublished - 2019 Jan 1

Keywords

  • Efficient price
  • High frequency data
  • Market microstructure noise
  • Mid price
  • Trade direction

ASJC Scopus subject areas

  • Statistics and Probability
  • Social Sciences (miscellaneous)
  • Economics and Econometrics
  • Statistics, Probability and Uncertainty

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