Microstructure Effect on Firm's Volatility Risk

Equity returns and fi rm's default probability are strictly interrelated financial measures capturing the credit risk profi le of a fi rm. Following the idea proposed in [20] we use high-frequency equity prices in order to estimate the volatility risk component of a fi rm within Merton [17] structural model. Di fferently from [20] we consider a more general framework by introducing market microstructure noise as a direct e ffect of using noisy high-frequency data and propose the use of nonparametric estimation techniques in order to estimate equity volatility. We conduct a simulation analysis to compare the performance of diff erent non-parametric volatility estimators in their capability of i) filtering out the market microstructure noise, ii) extracting the (unobservable) true underlying asset volatility level, iii) predicting default probabilities calibrated from Merton [17] model