Trading Volume and Exchange Rate Volatility: Evidence for the Sequential Arrival of Information Hypothesis

48 Pages Posted: 11 Feb 2011  

Raj Aggarwal

University of Akron; Federal Reserve Banks - Federal Reserve Bank of Cleveland

Mbodja Mougoue

Wayne State University - Finance

Date Written: December 1, 2010

Abstract

The relationship between trading volume and volatility in foreign exchange markets continues to be of much interest, especially given the higher than expected volatility of returns. Allowing for non-linearities, this paper tests competing hypotheses on the possible relationship between volatility and trading volume using data for three major currency futures contracts denominated in US dollars, namely the British pound, the Canadian dollar and the Japanese yen. We find that trading volumes and return volatility are negatively correlated, implying a lack of support for the mixture of distributions hypothesis (MDH). Using linear and nonlinear Granger causality tests, we document significant lead-lag relations between trading volumes and return volatility consistent with the sequential arrival of information (SAI) hypothesis. These findings are robust and not sample dependent or due to heterogeneity of beliefs as proxied by open interest. Furthermore, our results are insensitive to the modeling approach used to recover volatility measures. Overall, our findings support the contention that short to medium term currency relationships may be dominated by trading dynamics and not by fundamentals.

Keywords: Currency Markets, Sequential Information Arrival, Return Volatility, Trading Volume

JEL Classification: F31, G12, G15

Suggested Citation

Aggarwal, Raj and Mougoue, Mbodja, Trading Volume and Exchange Rate Volatility: Evidence for the Sequential Arrival of Information Hypothesis (December 1, 2010). Available at SSRN: https://ssrn.com/abstract=1758960 or http://dx.doi.org/10.2139/ssrn.1758960

Raj Aggarwal (Contact Author)

University of Akron ( email )

Akron, OH 44325-4803
United States

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

East 6th & Superior
Cleveland, OH 44101-1387
United States

Mbodja Mougoue

Wayne State University - Finance ( email )

328 Prentis Bldg.
5201 Cass Avenue
Detroit, MI 48202
United States
313-577-4538 (Phone)
313-577-0058 (Fax)

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