Which Daily Price is Less Noisy?


  • I thank Aurobindo Ghosh, Jun Yu, and especially an anonymous referee for many insightful suggestions and comments to improve the paper. I am also grateful to William G. Christie (the Editor) for his suggestions in the review process, and Sandra Sizer for editorial assistance.


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.