Accounting for the Epps Effect: Realized Covariation, Cointegration and Common Factors
نویسنده
چکیده
High-frequency realized variance approaches offer great promise for estimating asset prices’ covariation, but encounter difficulties connected to the Epps effect. This paper models the Epps effect in a stochastic volatility setting. It adds dependent noise to a factor representation of prices. The noise both offsets covariation and describes plausible lags in information transmission. Non-synchronous trading, another recognized source of the effect, is not required. A resulting estimator of correlations and betas performs well on LSE mid-quote data, lending empirical credence to the approach. ∗I am grateful to Neil Shephard for his support and advice. I thank warmly participants at a workshop organized by Nour Meddahi in Imperial College, London, on 22 February 2007.
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