Inferring Price Discovery from Frictional Markets

28 Pages Posted: 5 Mar 2000

See all articles by Kevin C.H. Chiang

Kevin C.H. Chiang

University of Alaska Fairbanks - School of Management (SOM); Louisiana State University, Baton Rouge - Department of Finance

Ji-Chai Lin

Hong Kong PolyU

Date Written: August 1, 1999

Abstract

This paper identifies measurement error when using high-frequency transaction price data in the estimation of error correction models and cointegration analysis. Within the framework of price discovery analysis, we show that high-frequency transaction price variables are not relevant to the conceptual variables of interest, that discreteness and bid-ask bounce are the sources of the measurement error, and that this measurement error results in biased estimates. To deal with this bias, we endogenize a vector of bid-ask components, re-identify the error correction model, and propose a modified algorithm for the calculation of Johansen's (1988) full-information maximum likelihood estimator. Numerical examples show that our procedure essentially eliminates the bias and that the procedure is more robust to data error.

JEL Classification: G0, G1, G2

Suggested Citation

Chiang, Kevin C.H. and Lin, Ji-Chai, Inferring Price Discovery from Frictional Markets (August 1, 1999). Available at SSRN: https://ssrn.com/abstract=194793 or http://dx.doi.org/10.2139/ssrn.194793

Kevin C.H. Chiang (Contact Author)

University of Alaska Fairbanks - School of Management (SOM) ( email )

P.O. Box 756080
208C Bunnell Building
Fairbanks, AK 99775-0500
United States
907-474-7049 (Phone)
907-474-5219 (Fax)

Louisiana State University, Baton Rouge - Department of Finance ( email )

E.J. Ourso College of Business Administration
Baton Rouge, LA 70803
United States
225-753-4978 (Phone)
225-388-6366 (Fax)

Ji-Chai Lin

Hong Kong PolyU ( email )

M715, Li Ka Shing Tower
Hung Hom, Kowloon
China

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