Bias-corrected realized variance under dependent microstructure noise

Abstract

The aim of this study is to develop a bias-correction method for realized variance (RV) estimation, where the equilibrium price process is contaminated with market microstructure noise, such as bid-ask bounces and price changes discreteness. Though RV constitutes the simplest estimator of daily integrated variance, it remains strongly biased and many estimators proposed in previous studies require prior knowledge about the dependence structure of microstructure noise to ensure unbiasedness and consistency. The dependence structure is unknown however and it needs to be estimated. A bias-correction method based on statistical inference from the general noise dependence structure is thus proposed. The results of Monte Carlo simulation indicate that the new approach is robust with respect to changes in the dependence of microstructure noise. JEL Classifications: C01; C13; C51

Pricing Nikkei 225 Options Using Realized Volatility

“…First, realized volatility is influenced by market microstructure noise induced by various market frictions, such as bid-ask spread and non-synchronous trading (Campbell et al, 1997). There are some methods available for mitigating the effect of microstructure noise on realized volatility (Zhou, 1996;Barndorff-Nielsen et al, 2004bAït-Sahalia et al, 2005;Zhang et al, 2005;Bandi and Russell, 2006Hansen and Lunde, 2006;Zhang, 2006;Kunitomo and Sato, 2008;Jacod et al, 2009;Oya, 2011). It is worthwhile applying these methods and comparing the results.…”