 Estimating covariation: Epps effect, microstructure noiseLan Zhang Journal of Econometrics, 2011, vol. 160, issue 1, 33-47 Abstract: This paper is about how to estimate the integrated covariance T of two assets over a fixed time horizon [0,T], when the observations of X and Y are "contaminated" and when such noisy observations are at discrete, but not synchronized, times. We show that the usual previous-tick covariance estimator is biased, and the size of the bias is more pronounced for less liquid assets. This is an analytic characterization of the Epps effect. We also provide the optimal sampling frequency which balances the tradeoff between the bias and various sources of stochastic error terms, including nonsynchronous trading, microstructure noise, and time discretization. Finally, a two scales covariance estimator is provided which simultaneously cancels (to first order) the Epps effect and the effect of microstructure noise. The gain is demonstrated in data. Keywords: Bias-variance; tradeoff; Epps; effect; High; frequency; data; Measurement; error; Market; microstructure; Martingale; Nonsynchronous; trading; Realized; covariance; Realized; variance; Two; scales; estimation (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:econom:v:160:y:2011:i:1:p:33-47 Access Statistics for this article Journal of Econometrics is currently edited by T. Amemiya, A. R. Gallant, J. F. Geweke, C. Hsiao and P. M. Robinson More articles in Journal of Econometrics from Elsevier |
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