TY  - JOUR
AU  - Diebold, Francis X
AU  - Strasser, Georg
TI  - On the Correlation Structure of Microstructure Noise: A Financial Economic Approach
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 16469
PY  - 2010
Y2  - October 2010
DO  - 10.3386/w16469
UR  - http://www.nber.org/papers/w16469
L1  - http://www.nber.org/papers/w16469.pdf
N1  - Author contact info:
Francis X. Diebold
Department of Economics
University of Pennsylvania
133 South 36th Street
Philadelphia, PA  19104-6297
Tel: 215/898-1507
Fax: 212/573-4217
E-Mail: fdiebold@sas.upenn.edu

Georg Strasser
Research Department
Europe
E-Mail: Georg.Strasser@ecb.europa.eu
AB  - We introduce the financial economics of market microstructure into the financial econometrics of asset return volatility estimation. In particular, we use market microstructure theory to derive the cross-correlation function between latent returns and market microstructure noise, which feature prominently in the recent volatility literature. The cross-correlation at zero displacement is typically negative, and cross-correlations at nonzero displacements are positive and decay geometrically. If market makers are sufficiently risk averse, however, the cross-correlation pattern is inverted. Our results are useful for assessing the validity of the frequently-assumed independence of latent price and microstructure noise, for explaining observed cross-correlation patterns, for predicting as-yet undiscovered patterns, and for making informed conjectures regarding improved volatility estimation methods.
ER  -