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Commonality, Information and Return/Return Volatility - Volume Relationship

Xiaojun He

Yeshiva University

Raja Velu

Syracuse University - Whitman School of Management

Chunnan Chen

National Cheng Kung University

AFA 2004 San Diego Meetings

This paper develops a common-factor model to investigate relationships between security returns/return volatility and trading volume. The model generalizes Tauchen and Pitts' (1983) MDH model by capturing possible interactions among securities. In our model, both price changes and trading volume are governed by three kinds of mutually independent variables: common factor variables, latent information variables and idiosyncratic variables. Despite its similarity to Hasbrouck and Seppi's (2001) model in terms of the form, the model extraordinarily allows us to identify the cause of interactions among securities by decomposing factor loadings into constant and random components. Three key implications are reached from our model. First, common factor structures in returns and trading volume stem from information flows. Second, returns' common factors are not related to trading volume's common factors. This implication directly opposes Hasbrouck and Seppi's (2001) assumption. Finally, cross-firm variations of returns and volume respectively rely on underlying latent information flows. The positive relation between return volatility and volume also results only from underlying latent information flows. Thus, common factor structures in returns and trading volume have no additional explanatory power in cross-firm variations and the positive return volatility-volume relationship. We fit the model for intraday data of Dow Jones 30 stocks using the EM algorithm. The results support specifications of our model. The empirical results demonstrate 3-factor structures in returns and trading volume, respectively. All 30 stocks in our sample are governed by at least one common factor. This fact implies that our model outperforms Tauchen and Pitts' (1983) model because their model is a special case of our model without the presence of common factors. We also show that after controlling the effect of information flows, persistence in return variance disappears.

Number of Pages in PDF File: 36

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Date posted: December 10, 2003  

Suggested Citation

He, Xiaojun and Velu, Raja and Chen, Chunnan, Commonality, Information and Return/Return Volatility - Volume Relationship. AFA 2004 San Diego Meetings. Available at SSRN: http://ssrn.com/abstract=475580 or http://dx.doi.org/10.2139/ssrn.475580

Contact Information

Xiaojun He (Contact Author)
Yeshiva University
500 West 185th Street
New York, NY 10033
United States
Raja Velu
Syracuse University - Whitman School of Management ( email )
721 University Avenue
Syracuse, NY 13244-2130
United States
Chunnan Chen
National Cheng Kung University ( email )
Tainan 701
Feedback to SSRN

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