Joel Hasbrouck
ABSTRACT
This paper describes a general approach to the estimation of security
price dynamics when the phenomena of interest are of the same scale or
smaller than the tick size. The model views discrete bid and ask quotes
as arising form the three continuous random variables: the efficient price
of the security, a cost of quote exposure (information and processing costs)
on the bid side and a similar cost of quote exposure on the ask side. The
bid quote is the efficient price less the bid cost rounded down
to the next tick; the ask quote is the efficient price plus the ask cost
rounded up to the next tick. To deal with situations in which the
cost of quote exposure possesses both stochastic and deterministic components
and the efficient price follows an EGARCH process, the paper employs a
nonlinear state-space estimation method. The method is applied to intraday
quotes at fifteen-minute intervals for Alcoa (a randomly chosen Dow stock).
The results confirm the existence of persistent intraday volatility. More
importantly they establish the existence of a persistent stochastic component
of quote exposure costs that is large relative to the deterministic intraday
'U' component.
Subject: Market Microstructure (Empirical)
Hasbrouck: (212) 998-0310 jhasbrou@stern.nyu.edu
http://www.stern.nyu.edu/~jhasbrou
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