On the Correlation Structure of Microstructure Noise in Theory and Practice


Shadow Workshop
University of Pennsylvania

3718 Locust Walk
410 McNeil

Philadelphia, PA

United States

Joint with: Francis X. Diebold

We use market microstructure theory to derive the cross-correlation function between latent returns and market microstructure noise. The cross-correlation at zero displacement is typically negative, and cross-correlations at nonzero displacements are positive and decay geometrically. When market makers are very risk averse, the cross-correlation pattern is inverted. The results may be useful for choosing among different market microstructure models and estimation of noise-robust measures of realized volatility.

For more information, contact Michela Tincani.

Georg Strasser

University of Pennsylvania