Volume-volatility puzzle and market liquidity

Proponente Sergio Bianchi - Professore Ordinario
Sottosettore ERC del proponente del progetto
Componenti gruppo di ricerca
Componente Qualifica Struttura Categoria
AUGUSTO PIANESE PROFESSORE ASSOCIATO UNIVERSITA' DEGLI STUDI DI CASSINO E DEL LAZIO MERIDIONALE Altro personale aggregato Sapienza o esterni, titolari di borse di studio di ricerca
MASSIMILIANO FREZZA CONTRATTISTA FACOLTA' DI ECONOMIA - SAPIENZA UNIVERSITA' DI ROMA Altro personale aggregato Sapienza o esterni, titolari di borse di studio di ricerca

The relation between stock price volatility and traded volume represents an open and challenging question, from both a theoretical and empirical point of view. The plethora of works appeared in the last decades on the causal relationship between traded volume and volatility achieved inconclusive or even contradictory results. Despite the old adage of Wall Street stating that it takes volume to move prices, a number of empirical works validated also the opposite implication, supporting the view according to which the volume weighs more in bull than in bear markets.
The literature concentrated mainly on two information theories: the Mixture of Distributions Hypothesis (MDH) and the Sequential Arrival of Information Hypothesis (SAIH). The MDH posits that volume and volatility are driven by the same information flow; therefore, they change simultaneously as soon as information is processed. Thus, the basic MDH does not consider effects as the lagged reactions to news or the interaction among types of traders. This simplification is questioned by the SAIH, which posits that the asymmetrically distributed information spreads sequentially from one trader to another and finds evidence of a lead-lag relationships.
The apparently contradiction in signs of the volume-volatility relation is the first motivation of this project, whose main purpose is to re-examine the contemporaneous relation from the perspective of market liquidity (and, ultimately, efficiency). If some our preliminary results confirm the MDH, when we control for the market liquidity, the relationship seems to reverse in illiquid phases. Our findings seem to suggest that when market behaves efficiently a positive correlation appears; vice versa, when market becomes inefficient a negative correlation arises. If confirmed by the research project, these findings could provide a rationale for the dichotomic results achieved by current literature.

SH1_4, SH1_6, PE1_21

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