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Noisy Prices and Inference Regarding Returns





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    • Elena Asparouhova and Hendrik Bessembinder are from David Eccles School of Business at the University of Utah. Ivalina Kalcheva is from Eller College of Management at the University of Arizona. The authors thank Shmuel Baruch; Peter Bossaerts; Michael Cooper; Wayne Ferson; Terry Hendershott; Sahn-Wook Huh; Michael Lemmon; Albert Menkveld; Mark Seasholes; Campbell Harvey; an Associate Editor; two anonymous referees; as well as seminar participants at the FMA Asia 2010 Conference, the University of California at Riverside, the Commodity Futures Trading Commission, Oxford University, Georgia State University, the University of Utah, the University of Arizona, the National University of Singapore, Rutgers University, Utah State University, the University of Oregon, the University of Wisconsin, the University of Porto, and Texas A&M University for helpful comments. The authors acknowledge the assistance provided by the Center for High Performance Computing at the University of Utah. Earlier versions of this manuscript were titled “Do Asset Pricing Regularities Reflect Microstructure Noise?”


Temporary deviations of trade prices from fundamental values impart bias to estimates of mean returns to individual securities, to differences in mean returns across portfolios, and to parameters estimated in return regressions. We consider a number of corrections, and show them to be effective under reasonable assumptions. In an application to the Center for Research in Security Prices monthly returns, the corrections indicate significant biases in uncorrected return premium estimates associated with an array of firm characteristics. The bias can be large in economic terms, for example, equal to 50% or more of the corrected estimate for firm size and share price.

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