THE DYNAMIC RELATION BETWEEN RETURNS, TRADING VOLUME, AND VOLATILITY: LESSONS FROM SPILLOVERS BETWEEN ASIA AND THE UNITED STATES

Authors


Bartosz Gębka, Newcastle University Business School, Ridley Building, 3rd Floor, Newcastle upon Tyne, NE1 7RU, UK. Tel: +44 191 222 6861; Fax: +44 191 222 6548; Email: b.t.gebka@ncl.ac.uk. The author thanks Jonathan Batten, Martin T. Bohl, Dobromil Serwa, Robert Sollis, Svitlana Voronkova, and participants of the Eastern Finance Association's 41st Annual Meeting, Norfolk, Virginia, USA, 3rd INFINITI Conference, Dublin, Ireland, and Global Finance Conference 2005, Dublin, Ireland, who provided helpful comments. The author is especially thankful to anonymous referees for their helpful suggestions which greatly improved the paper. All remaining errors are the author's responsibility.

ABSTRACT

This paper investigates the dynamic relationship between index returns, return volatility, and trading volume for eight Asian markets and the US. We find cross-border spillovers in returns to be non-existent, spillovers in absolute returns between Asia and the US to be strong in both directions, and spillovers in volatility to run from Asia to the US. Trading volume, especially on the Asian markets, depends on shocks in domestic and foreign returns as well as on volatility, especially those shocks originating in the US. However, only weak evidence is found for trading volume influencing other variables. In the light of the theoretical models, these results suggest sequential information arrivals, with investors being overconfident and applying positive feedback strategy. Furthermore, new information causes price volatility to rise due to differences in its interpretation among traders, but the subsequent market reaction takes the form of adjustment in price level, not volatility. Lastly, the intensity of cross-border spillovers seems to have increased following the 1997 crisis, which we interpret as evidence of increased noisiness in prices and diversity in opinions about news originating abroad. Our findings might also help to understand the nature of financial crises, to predict their further developments and consequences.

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