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Econometrics of Financial Models and Market Microstructure Effects

Published online by Cambridge University Press:  06 April 2009

Tom Smith
Tom Smith
Affiliation:
Fuqua School of Business, Duke University, Durham, NC 27708.
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Abstract

This paper addresses the problem of testing financial models in the presence of market micro structure effects. The moment restrictions implied by the financial and market microstructure models are jointly tested using Hansen's (1982) GMM approach. To illustrate the methodology, I consider the random walk model in combination with the bid-ask price effect model of Blume and Stambaugh (1983). Within this sufficiently simple framework, I obtain closed-form expressions for the estimators, standard errors of the estimators, and the test statistic, which affords an opportunity to examine the precision of the estimators and the power of the test as the return interval increases. I show that apparent rejections of the random walk model cannot be sustained when tests of the model are adjusted for market micro structure effects, and I discuss other applications of the methodology.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 29 , Issue 4 , December 1994 , pp. 519 - 540
Copyright
Copyright © School of Business Administration, University of Washington 1994

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