NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Dynamic Equilibrium and Volatility in Financial Asset Markets

Yacine Ait-Sahalia

NBER Working Paper No. 5479
Issued in March 1996
NBER Program(s):   AP

This paper develops and estimates a continuous-time model of a financial market where investors' trading strategies and the specialist's rule of price adjustments are the best response to each other. We examine how far modeling market microstructure in a purely rational framework can go in explaining alleged asset pricing `anomalies.' The model produces some major findings of the empirical literature: excess volatility of the market price compared to the asset's fundamental value, serially correlated volatility, contemporaneous volume-volatility correlation, and excess kurtosis of price changes. We implement a nonlinear filter to estimate the unobservable fundamental value, and avoid the discretization bias by computing the exact conditional moments of the price and volume processes over time intervals of any length.

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Document Object Identifier (DOI): 10.3386/w5479

Published: Journal of Econometrics, Vol. 84 (1998): 93-127. citation courtesy of

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