A closed-form formula characterization of the Epps effect

Giuseppe Buccheri, Giulia Livieri, Davide Pirino and Alessandro Pollastri

Quantitative Finance, 2020, vol. 20, issue 2, 243-254

Abstract: In this study we provide an analytical characterization of the impact of zero returns on the popular realized covariance estimator of Barndorff-Nielsen and Shephard [Econometric analysis of realized covariation: High frequency based covariance, regression, and correlation in financial economics. Econometrica, 2004, 72(3), 885–925]. In our framework, efficient price processes evolve as a semimartingale with some likelihood of repeated prices. We show that the standard realized covariance estimator is asymptotically affected by a downward bias, and the size of the bias depends on these likelihoods. We demonstrate that this result can be used to construct a consistent estimator of the integrated covariance of a vector semimartingale. The advantages with respect to other estimators are discussed with data.

Date: 2020
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DOI: 10.1080/14697688.2019.1659992

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