On Market Microstructure Noise and Realized Volatility

The Hansen-Lunde (HL) research program is generally first-rate, displaying a rare blend of theoretical prowess and applied sense. The present paper is no exception. In a major theoretical advance, HL allow for correlation between microstructure (MS) noise and latent price. (I prefer “latent price” to terms such as “efficient price” or “true price,” which carry lots of excess baggage.) In a parallel major substantive advance, HL provide a pioneering empirical investigation of the nature of the correlation between MS noise and latent price, documenting a negative correlation at high frequencies. My admiration of the paper hinges on the contributions noted above and is indeed most genuine. Nevertheless, much of what follows is rather critical of the extant literature, including certain key elements of the HL approach. My intention is that the criticism be constructive, promoting and hastening additional progress.