Volatility modeling and prediction : the role of price impact

Jiang, Y; Cao, Yi; Liu, X; Zhai, J

Abstract

In this paper, we are interested in exploring the role of price impact, derived from the order book, inmodeling and predicting stock volatility. This is motivated by the market microstructure literature thatexamines the mechanics of price formation and its relevance to market quality. Using a comprehensivedataset of intraday bids, asks, and three levels of market depths for 148 stocks in the Shanghai StockExchange from 2005 to 2016, we find substantial intraday impact from incoming bid and ask limitand market orders on stock prices. More importantly, the permanent price impact at the daily levelis a significant determinant of stock volatility dynamics as suggested by the panel VAR estimation.Furthermore, when we augment traditional volatility models with the time series of daily price impact,the augmented models produce significantly more accurate volatility predictions at the one-day aheadforecasting horizon. These volatility predictions also offer economic gains to a mean-variance utilityinvestor in a portfolio setting.

Citation

Jiang, Y., Cao, Y., Liu, X., & Zhai, J. (2019). Volatility modeling and prediction : the role of price impact. Quantitative Finance, 19(12), 2015-2031. https://doi.org/10.1080/14697688.2019.1636123

• Journal Article Type: Article
• Acceptance Date: Jun 20, 2019
• Online Publication Date: Jul 25, 2019
• Publication Date: Jul 25, 2019
• Deposit Date: Jul 15, 2019
• Publicly Available Date: Jan 25, 2021
• Journal: Quantitative Finance
• Print ISSN: 1469-7688
• Electronic ISSN: 1469-7696
• Publisher: Routledge
• Volume: 19
• Issue: 12
• Pages: 2015-2031
• DOI: https://doi.org/10.1080/14697688.2019.1636123
• Publisher URL: https://doi.org/10.1080/14697688.2019.1636123
• Related Public URLs: https://www.tandfonline.com/loi/rquf20
• Additional Information: Additional Information : Original title of article was 'Order book events : the price impact and its implication for volatility'; Funders : National Social Science Foundation of Education Bureau, China; Projects : Order Book Events: The Price Impact and Its Implication for Volatility; Grant Number: 17YJA790037