Modelling bid-ask spread conditional distributions using hierarchical correlation reconstruction

Duda Jarosław (), Henryk Gurgul and Syrek Robert ()
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Duda Jarosław: Jagiellonian University, Krakow, ; Poland .
Syrek Robert: Jagiellonian University, Krakow, ; Poland .

Statistics in Transition New Series, 2020, vol. 21, issue 5, 99-118

Abstract: While we would like to predict exact values, the information available, being incomplete, is rarely sufficient - usually allowing only conditional probability distributions to be predicted. This article discusses hierarchical correlation reconstruction (HCR) methodology for such a prediction using the example of bid-ask spreads (usually unavailable), but here predicted from more accessible data like closing price, volume, high/low price and returns. Using HCR methodology, as in copula theory, we first normalized marginal distributions so that they were nearly uniform. Then we modelled joint densities as linear combinations of orthonormal polynomials, obtaining their decomposition into mixed moments. Then we modelled each moment of the predicted variable separately as a linear combination of mixed moments of known variables using least squares linear regression. By combining these predicted moments, we obtained the predicted density as a polynomial, for which we can e.g. calculate the expected value, but also the variance to determine the uncertainty of the prediction, or we can use the entire distribution for, e.g. more accurate further calculations or generating random values. 10-fold cross-validation log-likelihood tests were conducted for 22 DAX companies, leading to very accurate predictions, especially when individual models were used for each company, as significant differences were found between their behaviours. An additional advantage of using this methodology is that it is computationally inexpensive; estimating and evaluating a model with hundreds of parameters and thousands of data points by means of this methodology takes only a second on a computer.

Keywords: machine learning; conditional distribution; bid-ask spread; liquidity.; C49; C58; G15. (search for similar items in EconPapers)
Date: 2020
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Related works:
Journal Article: Modelling bid-ask spread conditional distributions using hierarchical correlation reconstruction (2020)
Working Paper: Modelling bid-ask spread conditional distributions using hierarchical correlation reconstruction (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:vrs:stintr:v:21:y:2020:i:5:p:99-118:n:4

DOI: 10.21307/stattrans-2020-057

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