Which Daily Price Is Less Noisy?

The daily efficient price is the price that would prevail if the market were frictionless. I show that volume-weighted average price (VWAP) provides a less noisy estimate for the unobservable efficient price as compared to the closing price. The variance of daily returns computed with VWAPs is small...

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Bibliographic Details
Main Author: TING, Christopher
Format: text
Language:English
Published: Institutional Knowledge at Singapore Management University 2006
Subjects:
Online Access:https://ink.library.smu.edu.sg/lkcsb_research/1880
https://ink.library.smu.edu.sg/context/lkcsb_research/article/2879/viewcontent/Ting_2006_Financial_Management_DailyPriceNoisy.pdf
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Institution: Singapore Management University
Language: English
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Summary:The daily efficient price is the price that would prevail if the market were frictionless. I show that volume-weighted average price (VWAP) provides a less noisy estimate for the unobservable efficient price as compared to the closing price. The variance of daily returns computed with VWAPs is smaller than that computed with closing prices. The difference between these two realized variances is economically significant. The volatility of log closing price change tends to understate the beta risk and Sharpe ratio. A higher noise level in the closing price leads to derivative prices that favor option and volatility-related swap writers.