Estimating Risk in Illiquid Markets: a Model of Market Friction with Stochastic Volatility
Giuseppe Buccheri (),
Stefano Grassi () and
Giorgio Vocalelli ()
Additional contact information
Giuseppe Buccheri: DEF Università di Roma "Tor Vergata"
Stefano Grassi: DEF Università di Roma "Tor Vergata", http://www.ceistorvergata.it
Giorgio Vocalelli: DEF Università di Roma "Tor Vergata", http://www.ceistorvergata.it
No 506, CEIS Research Paper from Tor Vergata University, CEIS
We deal with the problem of estimating the volatility of a financial security in a market with frictions. To this end, it is proposed a microstructure model in which the trading price varies only if the value of the information signal is large enough to guarantee a profit in excess of transaction costs. The main statistical properties of such a model are derived and discussed extensively. Using transaction data only, the proposed approach allows to recover: (i) the conditional volatility of the information signal, which is thus cleaned out by market frictions, (ii) an estimate of transaction costs. Our analysis reveals that, after correcting for frictions, the risk of illiquid securities is substantially different from what predicted by traditional volatility models. Furthermore, in periods of high volatility, our estimate of transaction costs remains highly correlated with bid-ask spreads, whereas alternative illiquidity proxies, such as the fraction of zero returns, loose their explanatory power.
Keywords: Market microstructure; Illiquidity; Volatility estimation; Score-driven models (search for similar items in EconPapers)
JEL-codes: B26 C22 C58 (search for similar items in EconPapers)
Pages: 56 pages
Date: 2021-01-30, Revised 2021-11-08
New Economics Papers: this item is included in nep-mst, nep-ore and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed
Downloads: (external link)
https://ceistorvergata.it/RePEc/rpaper/RP506.pdf Main text (application/pdf)
This item may be available elsewhere in EconPapers: Search for items with the same title.
Export reference: BibTeX
RIS (EndNote, ProCite, RefMan)
Persistent link: https://EconPapers.repec.org/RePEc:rtv:ceisrp:506
Ordering information: This working paper can be ordered from
CEIS - Centre for Economic and International Studies - Faculty of Economics - University of Rome "Tor Vergata" - Via Columbia, 2 00133 Roma
Access Statistics for this paper
More papers in CEIS Research Paper from Tor Vergata University, CEIS CEIS - Centre for Economic and International Studies - Faculty of Economics - University of Rome "Tor Vergata" - Via Columbia, 2 00133 Roma. Contact information at EDIRC.
Bibliographic data for series maintained by Barbara Piazzi ().