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The relationship between trading activity and stock market volatility: Does the volume threshold matter?

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  • Koubaa, Yosra
  • Slim, Skander

Abstract

This paper examines whether trading activity conveys valuable information about changes in market volatility dynamics. We use a modelling framework, in which the market smoothly switches from one state to another, according to the volume level. Results show that large volume drives the high volatility regime for most of the markets, quite consistently with the disagreement-in-beliefs hypothesis. The volume decomposition into normal trading activity and surprising information arrival reveals a reverse threshold linkage for emerging markets. Results support the sequential information arrival hypothesis and highlight the key role of asymmetric information and thin trading in modelling the volume-volatility relationship. The proposed volume-based models provide significant forecast improvements over competing models and offer scope for investors to earn substantial profits.

Suggested Citation

  • Koubaa, Yosra & Slim, Skander, 2019. "The relationship between trading activity and stock market volatility: Does the volume threshold matter?," Economic Modelling, Elsevier, vol. 82(C), pages 168-184.
    • Handle: RePEc:eee:ecmode:v:82:y:2019:i:c:p:168-184
    DOI: 10.1016/j.econmod.2019.01.003
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    More about this item

    Keywords

    Volatility; Trading volume; Threshold effect; Forecast evaluation; Trading profit;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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