Separating Microstructure Noise from Volatility

There are two volatility components embedded in the returns constructed using recorded stock prices: the genuine time-varying volatility of the unobservable returns that would prevail (in equilibrium) in a frictionless, full-information, economy and the variance of the equally unobservable microstructure noise. Using straightforward sample averages of high-frequency return data recorded at different frequencies, we provide a simple technique to identify both volatility features. We apply our methodology to a sample of S&P100 stocks.

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