Stalking the "efficient price" in market microstructure specifications: an overview

in virtually all microstructure models, expectations of security payoffs are important determinants of prices and trading strategies. The principle that revisions to this expectation should be unpredictable implies a martingale property. This motivates empirical specifications in which the security price follows a random-walk plus transient disturbances that arise from the trading mechanism. This note is an overview of econometric approaches to characterizing the random-walk component in single- and multiple-price settings. Established techniques of random-walk decomposition provide useful characterizations of random-walk properties and (in the case of multiple markets) informational attributions. More general approaches based on the broader class of permanent/transitory decompositions suffer from problematic identification, a potential for misleading inference and lack of economic relevance. (C) 2002 Elsevier Science B.V. All rights reserved.