New Economics Papers
on Market Microstructure
Issue of 2012‒01‒10
two papers chosen by
Thanos Verousis

  1. Risk and Return: Long-Run Relationships, Fractional Cointegration, and Return Predictability By Tim Bollerslev; Daniela Osterrieder; Natalia Sizova; George Tauchen
  2. Measuring market liquidity: An introductory survey By Alexandros Gabrielsen; Massimiliano Marzo; Paolo Zagaglia

  1. By: Tim Bollerslev (Duke University and CREATES); Daniela Osterrieder (Aarhus University and CREATES); Natalia Sizova (Rice University); George Tauchen (Duke University and CREATES)
    Abstract: The dynamic dependencies in financial market volatility are generally well described by a long-memory fractionally integrated process. At the same time, the volatility risk premium, defined as the difference between the ex-post realized volatility and the market’s ex-ante expectation thereof, tends to be much less persistent and well described by a short-memory process. Using newly available intraday data for the S&P 500 and the VIX volatility index, coupled with frequency domain inference procedures that allow us to focus on specific parts of the spectra, we show that the existing empirical evidence based on daily and coarser sampled data carries over to the high-frequency setting. Guided by these empirical findings, we formulate and estimate a fractionally cointegrated VAR model for the two high-frequency volatility series and the corresponding high-frequency S&P 500 returns. Consistent with the implications from a stylized equilibrium model that directly links the realized and expected volatilities to returns, we show that the equilibrium variance risk premium estimated with the intraday data within the fractionally cointegrated system results in non-trivial return predictability over longer interdaily and monthly horizons. These results in turn suggest that much of the existing literature seeking to establish a risk-return tradeoff relationship between expected returns and expected volatilities may be misguided, and that the variance risk premium provides a much better proxy for the true economic uncertainty that is being rewarded by the market.
    Keywords: High-frequency data, realized volatility, options implied volatility, variance risk premium, fractional integration, long-memory, fractional cointegration, equilibrium asset pricing, return predictability.
    JEL: C22 C32 C51 C52 G12 G13 G14
    Date: 2011–12–21
  2. By: Alexandros Gabrielsen; Massimiliano Marzo; Paolo Zagaglia
    Abstract: Asset liquidity in modern financial markets is a key but elusive concept. A market is often said to be liquid when the prevailing structure of transactions provides a prompt and secure link between the demand and supply of assets, thus delivering low costs of transaction. Providing a rigorous and empirically relevant definition of market liquidity has, however, provided to be a difficult task. This paper provides a critical review of the frameworks currently available for modelling and estimating the market liquidity of assets. We consider definitions that stress the role of the bid-ask spread and the estimation of its components that arise from alternative sources of market friction. In this case, intra-daily measures of liquidity appear relevant for capturing the core features of a market, and for their ability to describe the arrival of new information to market participants.
    Date: 2011–12

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