Volume-Return Relationship in ETF Markets: A Reexamination of the Costly Short-Sale Hypothesis

This study aims to investigate whether the costly short-sale theory is responsible for the volume-return relationship in Taiwan’s ETF market. Through a model specification, we demonstrate that trading volume and returns for ETFs and their underlying assets exhibit an asymmetric relationship with significantly larger volume associated with negative returns than with non-negative returns, a finding that verifies the prediction of the costly short-sale hypothesis. Using quantile regression, we also find that the magnitudes of the volume-return correlations and subsequent asymmetric effects vary with the ETF volume levels. The asymmetric effects are more obvious at the volume quantiles that are higher than the median level and at the extrema quantiles. Notably, that the strongest asymmetric relationship occurs at the extrema quantiles for both ETFs may stem largely from the sharp increases in the correlations between volume and negative underlying index returns for the extrema quantiles. We try to use the hybrid effects, complementary and substitute effects for both ETF and spot investors, to explain this phenomenon.