High Frequency Market Microstructure Noise Estimates and Liquidity Measures

Yacine Ait-Sahalia (Princeton University), Jialin Yu* (Columbia University)


Abstract: This paper decomposes the transaction prices of NYSE stocks into a fundamental component and a microstructure noise component. We relate the two components to observable financial characteristics, and in particular to different observable measures of stock liquidity. More liquid stocks have lower noise and noise-to-signal ratio measured recent developments in the high frequency econometric literature. Using daily liquidity measures, we construct a single index for microstructure noise which allows extrapolation back when intra-day data are unavailable.