The Endogeneity of Trading Volume in Stock and Bond Returns: An Instrumental Variable Approach
42 Pages Posted: 3 Apr 2019
Date Written: May 2019
This paper investigates the joint determination of trading volume and returns. Our approach follows from the argument that trading activity depends on security returns, thus resulting in a reverse causality from returns to trading activity. Using exogenous instruments for security trading activity, we estimate a system of two‐stage simultaneous equations to better model the return‐volume relationship. Our results confirm that returns and trading volume are determined simultaneously in both stock and corporate bond markets and that conclusions about the direction and significance of causality between volume and returns can be reversed once one corrects for the endogeneity of volume.
Keywords: endogeneity, simultaneity, trading volume, security returns, two‐stage least squares
JEL Classification: C18, C30, C36, G10, G12
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